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Big Blue: Stock Buyback Machine On Steroids

Tyler Durden's picture




 

Submitted by David Stockman of Contra Corner

Big Blue: Stock Buyback Machine On Steroids

The Fed’s financial repression policies destroy price discovery and honest capital markets. In the process these deformations turn financial markets into casinos and corporate executives into prevaricating gamblers. To be specific, most CEOs of the Fortune 500 are no longer running commercial businesses; they are in the stock-rigging game, harvesting a mother lode of stock option winnings as the go along.

Those munificently rising stock prices and options cash-outs owe much to the Fed’s campaign to suppress interest rates and fuel stock market based ”wealth effects”, but the CEOs are doing their part, too. They have become full-time financial engineers who use the Fed’s flood of liquidity, cheap debt and soaring stock prices to perform a giant strip-mining operation on their own companies.  That is, through endless stock buybacks and M&A maneuvers they create the appearance of “growth” while actually liquidating the balance sheet equity and future asset base on which legitimate earnings growth depends.

The poster boy for this deformation is IBM which for all intents and purposes has become a stock buyback machine on steroids. It had a bad hair day yesterday, reporting still another year/year decline in sales, but that goes right to the heart of the matter. During the last seven years IBM has been a stock traders dream, climbing an almost picture perfect chart from $94 per share in March 2007 to a recent peak of $212.

But as shown below, those gains had nothing to do with what has been a historic ingredient of stock appreciation—-namely, expansion of its asset base and revenues. In fact, sales revenues in Q1 2014 clocked in at virtually the same number as Q1 2007:

So how has IBM and its ilk achieved revenue-less earnings growth? After all, reported EPS has gone from about $7 per share to $15 during the period. The short answer is that its executives and board have utilized every accounting and financial engineering short-cut in the book to disguise an equity liquidation campaign as a splendid strategy for “growth”.

During the 7-years ending in 2013 IBM booked about $100 billion in net income, and spent virtually every single penny on share buy backs. So the once and former king of the global high-tech industry had nothing better to do with its cash than shrink it equity base. Accordingly, its share count dropped by 20% over the period, thereby accounting for about 45% of its EPS growth.

Moreover, it also distributed another $20 billion in dividends over the 7-year period. In all, it delivered cash into the maws of the fast money and hedge fund complex that amounted to 120% of its net income for 2007-2013. Needless to say, the robo traders can never get enough of this kind of “shareholder friendly” action at any given moment in time–no matter that it amounts to corporate liquidation eventually.

Coughing up rivers of cash was only one arrow in the quiver of  IBM’s shareholder value enhancement strategy, however. Its lawyers and  accountants weighed in smartly, too. During fiscal 2007 Big Blue’s tax rate was already low at 28%, but by dint of the best tax maneuvers money can buy, IBM’s tax provision dropped to just 15.5% last year. So if you hold constant IBM’s tax rate and share count at the 2007 level, EPS would have been about $9.50/share in 2013, not the $15 reported.

Yet even that modest 5% growth rate since 2007 isn’t all that. IBM also spent nearly $25 billion on “acquisitions” during the period—financing these deals with the kind of ultra-cheap blue chip corporate debt issues that has been on fire sale since the Fed lowered the boom on the government benchmark rate under QE. Consequently, IBM’s acquisitions are inherently and prodigiously “accretive” to per share earnings not because they make any economic sense, but because its after-tax cost of debt capital is nearly zero.

It might wondered, however, why a globe spanning company with $100 billion in revenues, top-drawer facilities, limitless professional  talent and a huge legacy of intellectual capital needs to shuffle around Wall Street making two-bit M&A deals on a continuous basis—that is, why it doesn’t build rather than “buy”.

But then just check out the “cookie jar” of accounting reserves it establishes on each deal completion along with its near zero-cost of debt capital. It becomes quickly evident that EPS “accretion” on an accounting basis may have virtually no relationship whatsoever to genuine corporate value creation–the ostensible point of the mindless M&As that preoccupy the C-Suites of corporate America.

Indeed, IBM’s financials make it self evident that its stock rigging strategy is not about value creation thru “investment”. Thus, during the past seven years IBM has consumed about $35 billion in DD&A charges, but invested less than $30 billion in Capex. Even if IBM has gone the “services and software” route, it might by questioned how a technology giant can prosper over time by consuming 15% of its capital assets each and every year.

And that’s especially true since its R&D expense line is going south even faster. In 2007 it spent about $6.2 billion generating new products, processes and intellectual capital; last year in inflation-adjusted dollars it spent $5.5 billion or nearly 15% less.

In short, IBM is a poster boy for the deformation of American capitalism that has resulted from monetary manipulation and central planning. Today it carries nearly $40 billion of super-cheap debt—up by nearly 21% from 2007. It has used that gift from the Eccles Building to make ends meet—that is, carry on operations while it steady liquidates its capital and feeds prodigious amounts of cash into the Wall Street casino.

Yes, IBM is a buy back machine on steroids that has been a huge stock market winner by virtue of massaging, medicating and manipulating its EPS. But eliminate the accounting razzmatazz, M&A tricks and under-investment— and IBM’s true earnings might be fairly estimated at $8/adjusted share.

That means that even after today’s hit Big Blue is valued at nearly 24X. And that’s for a company that has not grown in 7 years; which has had a weak-dollar tail-wind inflating its earnings; and has now become personae non-grata in much of the BRIC world due to its service to the Spy State in Washington.

Under those circumstances,  the next “M” may stand for monkey-hammered.

Below is an excerpt from ”The Great Deformation: The Corruption Of Capitalism In America” where this baleful tale of corporate self-liquidation was first exposed(pp 563-565)

BIG BLUE: STOCK BUYBACK CONTRAPTION ON STEROIDS

 

IBM’s huge share buyback program, by contrast, shows that financial engi- neering does not always produce such immediate untoward results. Yet it is nonetheless a dramatic illustration of how the Fed’s bubble finance régime enables companies to literally “buy” themselves a higher stock price, at least temporarily, by plowing massive amounts of cash into share repurchases, thereby creating the false impression of robust earnings growth.

 

Big Blue’s reported earnings thus surged 16 percent annually from $7 per share in 2007 to $13 in 2011, but those results were not apples to apples by any stretch of the imagination. The company’s stock buyback program re- duced its net share count by 22 percent, and profits on its massive overseas operations had been artificially boosted by a double-digit decline in the dollar. IBM’s reported results also reflected a 12 percent reduction in its tax rate and $16 billion of acquisitions, all highly accretive mainly because they were financed with ultra-cheap long-term debt.

In the absence of these one-timers and financial engineering maneu- vers, however, the picture was not so buoyant. Based on organic revenues, constant exchange rates, and no reduction in tax rates and share counts, earnings per share grew by about 5 percent annually, not 16 percent, over the past five years. It is far from evident, therefore, that IBM’s true mid- single-digit growth rate justified the doubling of its share price during the period.

 

Upon closer examination, in fact, IBM was not the born-again growth machine trumpeted by the mob of Wall Street momo traders. It was actu- ally a stock buyback contraption on steroids. During the five years ending in fiscal 2011, the company spent a staggering $67 billion repurchasing its own shares, a figure that was equal to 100 percent of its net income.

 

This massive and continuous stock-buying program brought approxi- mately 550 million, or 36 percent, of the company’s 1.5 billion of outstand- ing shares into its treasury, but needless to say, they did not all stay there. Nearly two-fifths of these shares reentered the float, mainly to refresh the management stock option kitty.

 

It goes without saying that in this instance the interests of stock traders and top management were aligned—perversely. The steady, deep shrink- age of the IBM float kept a bid under the stock and thereby delivered a “perfect” price chart, rising almost continuously from $100 to $200 per share over the past five years. It was a carry trader’s dream.

 

Likewise, top executives got big-time pay packages they may or may not have deserved, but in any event they were dispensed in envelopes marked “tax once over lightly.” Former CEO Sam Palmisano, for example, cashed out $110 million worth of stock options a few weeks after his retirement party.

 

This rinse-and-repeat shuffle of stock buybacks and options grants is undoubtedly a significant source of left-wing jeremiads about executive pay having gone to three hundred times the average worker’s compensa- tion when, once upon a time, allegedly, the ratio was more like 30 to 1. But the issue is not simply whether this kind of financial engineering has con- tributed to the sharp tilt of income flows to the top 1 percent in recent years. There can be little doubt, on the math alone, that it has.

 

The more crucial question, in this instance, is whether the massive CEW evident in IBM’s numbers is setting up another of the great iconic American companies for a fall sometime down the road, similar to Hewlett-Packard. The data on this score are not encouraging. Total shareholder distributions, including dividends, amounted to $82 billion, or 122 percent, of net income over this five-year period. Likewise, during the last five years IBM spent less on capital investment than its depreciation and amortization charges, and also shrank its constant dollar spending for research and development by nearly 2 percent annually. Neither of these trends is compatible with stay- ing on top in the fiercely competitive global technology industry.

 

Most especially, however, IBM’s earnings—like nearly all the big cap global companies—could not be flattered permanently by the Fed’s bubble finance. Already, the plunge of the euro has taken a toll on the company’s reported results, causing the artificial translation gains it booked on its huge European businesses during the weak dollar cycle through 2011 to now unwind. Indeed, with nearly two-thirds of its sales outside the United States, the company’s sales are now actually falling in dollar terms, and will likely continue to do so for the indefinite future.

 

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Thu, 04/17/2014 - 13:08 | 4670008 Dumpster Fire
Dumpster Fire's picture

snake eating it's tail

Thu, 04/17/2014 - 13:26 | 4670060 666
666's picture

No wonder the CEOs "earned" bigger and bigger bonuses.

Thu, 04/17/2014 - 14:49 | 4670382 zaphod
zaphod's picture

To be fair, it is the current tax structure that encourages stock buybacks.

Stock buybacks are a method to return capital to equity owners without paying taxes. Dividends are taxed, but buybacks are not. 

Yes, if you only look at earnings per share then EPS will be artificially inflated, but who looks at just that?

Thu, 04/17/2014 - 13:19 | 4670024 TheRideNeverEnds
TheRideNeverEnds's picture

Just borrow money for basically nothing and buy your own stock from yourself to boost the price of the options you hold.  All indexes go straight up as the little guy is smothered with inflation and taxes you get bonuses all around.  Its a brilliant strategy if you think about it. 

Thu, 04/17/2014 - 13:25 | 4670059 LawsofPhysics
LawsofPhysics's picture

Just like robbing the taxpayer at gunpoint for a zero interest loan, only to loan it right back for a much higher interest rate...

 

Thu, 04/17/2014 - 13:36 | 4670081 TheRideNeverEnds
TheRideNeverEnds's picture

Well in fairness the Torah and Talmud encourage the granting of loans that do not involve interest to other members of the tribe, interest on loans is frowned upon. However loans at interest to the goy are permissible as goyim are sub humans, lower than animals; servants to be used as seen fit by the chosen people.  Its all in the texts and is the playbook by which our system operates for what I think should be obvious reasons....  

Thu, 04/17/2014 - 13:20 | 4670046 derek_vineyard
derek_vineyard's picture

bad is good, good is good, worse is best......go SPX

its all good

Thu, 04/17/2014 - 13:24 | 4670054 LawsofPhysics
LawsofPhysics's picture

Well they had to do something, I think the taxpayer is starting  to catch on to the whole "loan them money only to have them loan it back to us at a higher interest rate" scam...

Thu, 04/17/2014 - 13:32 | 4670079 TideFighter
TideFighter's picture

Just curious...are these taxpayers the same people as the voters? err, forget that , dumb fucking question

Thu, 04/17/2014 - 13:25 | 4670058 Flakmeister
Flakmeister's picture

If you think IBM is bad, try the same analysis on XOM and be sure to take into account how nat gas is booked as BOEs in the reserve calcs....

Thu, 04/17/2014 - 13:34 | 4670082 Fuh Querada
Fuh Querada's picture

yeah right, I was just going to ask which companies DON'T perpetrate this con game....

Thu, 04/17/2014 - 14:07 | 4670195 magnetosphere
magnetosphere's picture

how much relatively cheap extractable nat gas is there in usa and worldwide?

Thu, 04/17/2014 - 14:13 | 4670221 Flakmeister
Flakmeister's picture

You are going to have to be a wee bit more specific than that...

Thu, 04/17/2014 - 18:39 | 4670278 magnetosphere
magnetosphere's picture

http://www.oilcrisis.com/bentley/depletionOverview.pdf

aie.org.au/AIE/Documents/EWG-update2013_long_18_03_2013.pdf

http://gaia.pge.utexas.edu/papers/PatzekManuscriptRevised.pdf

these guys claim 2 TBOE ultimate recov resource in nat gas.  have these estimates changed significantly over the years?

Thu, 04/17/2014 - 13:26 | 4670061 The_Dude
The_Dude's picture

Wheee....watch that debt/equity level fly!!!  Better hope those cash flows keep coming or this ol' business machine may seize up

Thu, 04/17/2014 - 13:26 | 4670063 Seasmoke
Seasmoke's picture

You would think whoever times this market right will become richer than bill gates. However collecting your winnings is probably worthless or not going to happen. So I think most of us at ZeroHedge blew it. There was only one way to play this market. Because when the collapse happens it just won't matter. Plus you got to live like a king for 6-7 years.

Thu, 04/17/2014 - 13:29 | 4670071 Reference Variable
Reference Variable's picture

I very much prefer the buybacks to buying overinflated companies. You can't post shit here everyday about peak market and then criticize IBM for using their cash for buybacks.

Thu, 04/17/2014 - 13:31 | 4670076 Rainman
Rainman's picture

It's probably sexist to say IBM is another corporate and Fed behemoth turned over to the females just before the wheels come off ... so I won't mention it.

Billary '16

Thu, 04/17/2014 - 13:31 | 4670078 Seasmoke
Seasmoke's picture

At the track I hate guys who complain there 10-1 lost to the 3-5 by a nose. And then brag they had the right horse. Yes kudos , for picking the priced horse who was going to fire, however you are still tearing up your tickets.
Some reason , I don't have the same mentality here. I get beat by the 1-9 FED horse everyday, but I always think I am seeing what no one else is seeing and Tommorow will be the day. However I'm still losing daily , just like the guy at the track

Thu, 04/17/2014 - 13:34 | 4670084 TideFighter
TideFighter's picture

10-1 horses turn into gorilla glue. and..jello

Thu, 04/17/2014 - 13:37 | 4670088 fonzannoon
fonzannoon's picture

can anyone on here make sense of this? Look at Crude/Nat gas plus agricultural commodities blowing out and yet gold, the grand daddy inflation hedge, continues to blow ass. Unreal.

Thu, 04/17/2014 - 13:36 | 4670091 ejmoosa
ejmoosa's picture

In 2006 it would have taken 1.46 years of profit for IBM to pay off it's long term debt.

in 2013, it would have taken 1.99 years of profit to pay off it's long term debt.

They are not growing their business.  They are just borrowing money and buying back shares.

At the first real uptick in interest rates, the gig will be up.

 

Thu, 04/17/2014 - 13:45 | 4670122 The_Ungrateful_Yid
The_Ungrateful_Yid's picture

1815 is the line and its held the two hilarious corrections if you will so far.

Thu, 04/17/2014 - 13:50 | 4670136 rosiescenario
rosiescenario's picture

I've mentioned this simple fact a few times on ZH....management uses stock buybacks to make their options of value. Since members of the BODs also have options, they do not discourage this use of funds.

 

Of course this is a rather questionable use of the shareholders' money, but this how the system works. It becomes even more questionable if the company is borrowing money (pledging shareholders' assets) in order to do this.

Thu, 04/17/2014 - 13:54 | 4670152 pragmatic hobo
pragmatic hobo's picture

where would the market be without stock buybacks?

Thu, 04/17/2014 - 13:58 | 4670165 buzzsaw99
buzzsaw99's picture

ibm isn't so bad, at least they make a profit. the poster boys are of the nflx and fb ilk. 100X - 1000X - negative infinity X and yet they can sell umpteen bazillion dollars in stock to hedge fund jackasses on margin.

 

there's a sucker born every minute

Thu, 04/17/2014 - 14:13 | 4670220 TideFighter
TideFighter's picture

Saw some numbers whereby polls indicated that low wage earners will be droving to Texas, Florida, and other southern states due to accumulated utility bills (large over-the-winter) gas bills being financed (only with direct pay) for 24 months. Makes sense that they are giving up, since 24 months takes them thru two more financial the utuilty bill cycles? Uitlity bills forcing families together in one house, but housing is going to pick up?  

Thu, 04/17/2014 - 14:25 | 4670268 buzzsaw99
buzzsaw99's picture

what's funny is watching blackstone et al buying copious residential real estate to rent out. i guess no-one told them that it only takes renters a few months to completely trash a house then they stop paying and move on after the lengthy eviction process. i'm sure they intend to flip their billions in houses to some greater fool but that fool will not be coming anytime soon for the very reasons you mentioned.

Thu, 04/17/2014 - 14:58 | 4670418 Kayman
Kayman's picture

It is amazing to me how many public corps. make Zero earnings.  Many have never had cash earnings. Only their ablitity to sell shares, new debt and roll over old debt keeps them alive.

The Fed wittingly or unwittingly has killed this country.

Thu, 04/17/2014 - 21:38 | 4671736 AdvancingTime
AdvancingTime's picture

Your comment made me think of Japan. Years ago before the "Bernanke has all the answers" era, many of us criticized Japan for failing to own its problems. Many people thought Japan should face up to the mess it had created and do the right thing. Broadly accepted was the concept that only by letting its zombie banks and industries fail could Japan clean out the system and move forward. The article below explores  how we could be looking at lost decades.

http://brucewilds.blogspot.com/2013/11/we-are-on-path-to-lost-decades.html

Thu, 04/17/2014 - 14:46 | 4670372 pitz
pitz's picture

They fired a crazy number of Americans, and started using an enormous number of H-1B visas and other outsourcing scams to meet those "numbers".  And even then, their reputation is being rapidly eroded through the ongoing reduction in quality. 

Go read Cringley sometime, IBM is the epitome of a modern "fucked company". 

Thu, 04/17/2014 - 16:07 | 4670543 Youri Carma
Youri Carma's picture

IBM has struggled in a shift to the cloud era, where data and information are delivered online instead of being stored onsite.

Falling demand for hardware and weak sales in growth markets have dragged down revenue for the last seven quarters, prompting Rometty to sell assets, fire and furlough workers, buy back shares and cut taxes to help meet profit goals.

FROM: IBM’s Rometty Says Company Didn’t Meet Expectations in 2013 http://www.bloomberg.com/news/print/2014-03-09/ibm-ceo-rometty-says-comp...

Revenues in the BRIC countries — Brazil, Russia, India and China — decreased 11% percent (down 6%, adjusting for currency).

And so the Snowden curse strikes again, as countries which don't enjoy being constantly spied upon opt to not to business with the companies they believe are most instrumental in allowing the NSA into their midst.

FROM: Why IBM Is Tumbling: BRIC Sales Plunge, Total Revenue Lowest Since 2009 http://www.zerohedge.com/news/2014-04-16/why-ibm-tumbling-bric-sales-plu...

Thu, 04/17/2014 - 21:32 | 4671720 AdvancingTime
AdvancingTime's picture

This article dovetails with a piece I wrote a while back. It explored how money has become so cheap to borrow that many people are now arguing that you must take it even if you don't know what to do with it. It is hard to imagine how much this is distorting the economy, markets, and reality in general. A total disconnect between life on main street and the financial world is occurring and it is putting the economy in a very dangerous place. More on the subject of all this cheap money in the article below.

http://brucewilds.blogspot.com/2013/05/cheap-money-more-and-more-and-mor...

Do NOT follow this link or you will be banned from the site!