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The Great Stock Buyback Craze Is Finally Ending

Tyler Durden's picture




 

As we reported last night, whether as a result of Snowden revelations and NSA blowback by BRIC nations, or simply because the global economy is contracting far faster than rigged and manipulated markets worldwide will admit, IBM's Q1 revenues not only missed consensus earnings, but dropped to their lowest level since 2009. And yet, IBM stock is just shy off its all time highs and earnings per share have been flat if not rising during this period, leading even such acclaimed investors who never invest in tech companies as Warren Buffett to give IBM the seal of approval. How is that possible?

Simple: as we forecast first in 2012, all that investment grade companies like IBM have done in the New Normal in order to preserve the illusion of growth, is to use cash from operations, or incremental zero-cost leverage, to fund stock buybacks with the express goal of reducing the number of shares, and hence dilution, in the EPS calculation. In essence a balance sheet for income statement tradeoff. Earlier today, David Stockman touched just on this issue.

However, that "great stock buyback craze" as we call it, is finally coming to an end.

Why?

Before we explain, in order for readers to get a sense of the true perspective of how massive IBM's stock buybacks have been over the past two years, here is a chart showing the quarterly amount of net debt issued by Big Blue as well as the total notional in stock buybacks.

 

 

And yes, in the just completed quarter, IBM bought back a record $8+ billion of its own stock.

Before we proceed, for those wondering if IBM is allocating more cash to buybacks or capex, here is a quick and simple explanation.

 

As the chart above shows, since 2012, IBM has used roughly four times as much cash to spend on stock buybacks, as it has on capital expenditures. And not only IBM: this relationship is largely true of most investment grade companies. Incidentally, for anyone curious why there is no revenue growth, show them this chart. As long as corporate management teams seek to appease hedge fund raiders and activist shareholders who merely intend to use a company as a leveragable piggy bank vessel for a brief period of time, and buybacks explode at the expense of true investment in the future by way of capex, there simply can not be true organic growth. Period.

Now going back to the original topic, here is the first chart above presented in the form of a snapshot in time, showing that since the start of 2012 nearly identical amounts have been spent to fund stock buybacks as has been raised through net debt issuance: some whopping $34 billion of buybacks to be precise.

 

 

Summarizing the chart above: in the past 2+ years, virtually every dollar in debt IBM has issued has gone for shareholder friendly actions (this chart does not include some $8.8 billion in dividends over the same time period).

Which brings us to the topic at hand. While for a over a year, starting in 2012, IBM generated enough cash to where the incremental debt-funded buybacks did not result in a major change in the company's net leverage, starting about a year ago, organic cash flow declined so much that IBM had no choice but to see its net debt surge, and in fact since Q1 2012 has risen from $20 billion to nearly $35 billion, a 75% increase in just about two years!

 

 

But while net debt soaring is an unpleasant, if perfectly expected consequence of trying to mask income statement weakness with ever more debt, the piece de resistance is a chart showing IBM's Debt to Equity ratio. Because while a company can grow its debt indefinitely for a long time, unless it is also generating retained earnings, the party is ending. And as of this quarter, IBM's debt to equity ratio has risen to the highest on record, surpassing even the highs hit during the Lehman crisis!

 

One can be certain that the rating agencies are certainly taking a long hard look at this massive jump and are currently wonder if and to what degree they should cut IBM's credit rating.

Which, in turn, leaves Big Blue in a very unpleasant situation: should it continue buying back stock at record levels, all funded through new debt issuance, but at least preserving for one more quarter the illusion that EPS is stable and maybe even growing while revenues keep declining in the process risking the very basis of what allowed the company to kick the can for so long, its pristine credit rating, or should IBM finally throw in the towel, and instead preserve its balance sheet while allowing EPS to finally track revenue growth. Or lack thereof.

Considering that for IBM its balance sheet is far more precious than its income statement and what its stock does over the near-term (all the more so since unlike many other companies it is not being accosted by random pesky hedge fund activists) especially since its price per share is just shy of all time highs, we can only assume that IBM will promptly slow down if not end outright, its stock buyback gimmick routine. First IBM, and then every other investment grade company that like Big Blue has postponed the day of income statement reckoning by unleashing record amounts of debt on what was once upon a time a pristine balance sheet.

Which is naturally great news for those who are sick and tired of every form of manipulation and rigging big and small that has been plaguing the market ever since Bernanke made capital markets a policy vehicle for the Fed's central-planning mandate. Because once the buyback fraud is gone, and the crackdown on HFTs' market rigging and order frontrunning practices is complete, the only entity responsible for a criminally manipulated market will be none other than the Federal Reserve. Luckily, with Yellen in charge, it is only a matter of time before that final support of this epically-rigged travesty formerly known as the market, gives way and ushers in the grand reset so critical for restoring investor faith in what was once a real and fair marketplace.

 

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Thu, 04/17/2014 - 16:36 | 4670819 sessinpo
sessinpo's picture

Hardly.

There is still at least one more push to higher prices.

Thu, 04/17/2014 - 16:39 | 4670826 negative rates
negative rates's picture

Was that push or purse?

Thu, 04/17/2014 - 16:45 | 4670845 DoChenRollingBearing
DoChenRollingBearing's picture

IBM had a nice run for many years.  I am lucky to have a slice.  Time to sell?

***

And stocks as a whole? I have been a bear so long my forward thinking is worth nothing...

Thu, 04/17/2014 - 17:02 | 4670870 NotApplicable
NotApplicable's picture

Tyler, did you forget to add the "Thursday Humor" tag?

Thu, 04/17/2014 - 17:15 | 4670901 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

The privileged class and their games to cover up a simple reality, the US and western world is broke. Their charades will end some day. I just wish these games were known before they ran the rigged markets up to ridiculous heights post-Lehmann. 

Fri, 04/18/2014 - 02:37 | 4672293 Wait What
Wait What's picture

my guess is the game ends when the BRICS finally establish that IMF-type organization TD mentioned and say F U! to the west. at that point they won't need the dollar/yen/euro, won't need the money borrowed to lend that is holding the status quo together, won't need the natural resources the west doesn't have anyway.

it also seems like saying 'the west is broke' needs to be understood as the GOVERNMENTS of the west are broke, and all the potential profits have been taken and put into private hands. there is plenty of wealth in the west, it's just not contributing to the fiscal well-being of western governments. why should it? government is a 'public good' in the technical sense, and wealth can free ride til the wheels fall off.

Thu, 04/17/2014 - 16:37 | 4670822 _ConanTheLibert...
_ConanTheLibertarian_'s picture

Nice analysis!

Fri, 04/18/2014 - 02:13 | 4672273 Wait What
Wait What's picture

+1

might be the best post this week.

it's usually these pithy, under the radar ZH revelations that turn into bigger stories down the road, but i won't hold my breath waiting for the sheep to catch on.

Thu, 04/17/2014 - 16:42 | 4670831 centerline
centerline's picture

Just more and more evidence of time running out for the current round of financial gimmicks. Something is bound to give here in 2014 one way or another.

Thu, 04/17/2014 - 18:30 | 4671099 ArkansasAngie
ArkansasAngie's picture

They will try very hard for anything to happen post the November election.  A crash now would not be politically correct.

Thu, 04/17/2014 - 20:59 | 4671595 Shizzmoney
Shizzmoney's picture

Au contraire,

I think they organize these crashes AROUND election times (specifically POTUS election times) to confuse and cajole the aloof populace into going with what they want. 1987 = flash crash, 1999 = dotcom, 2008 = housing.  People go to the polls to vote for some populist Atlas character, who says the right things and then turns around and screws them up the ass.  List goes on and on.

Also, there is the usual pullback from the market around this time because people are a little worried about their potential tax liability and how that can change.  1991's recession was a direct result of Bush I lying about raising taxes (because he had to pay for a war), on top of S&L shenenegians coming home to roost.

Thu, 04/17/2014 - 16:45 | 4670842 Rainman
Rainman's picture

And all these years I thought prudent public corporates retired stock because they felt it was cheap ... silly me.

Thu, 04/17/2014 - 17:09 | 4670887 NoDebt
NoDebt's picture

Lots of corporate executives are paid a portion of their earnings in company stock or have bonuses tied to share price.  

Thu, 04/17/2014 - 17:18 | 4670902 Rainman
Rainman's picture

bbut wouldn't that encourage fraud and manipulaion ?... , just curious

Thu, 04/17/2014 - 17:22 | 4670918 spine001
spine001's picture

Company buybavks have always been used to allow friendly hedge funds or insider investors to get their, money out at higher than market prices. Tons of academic studies on this. Even the infamous Kramer used to educate his audience about this.

Thu, 04/17/2014 - 19:29 | 4671295 SillySalesmanQu...
SillySalesmanQuestion's picture

That was Kramer pre-coke and pre-CNBS propaganda. He is owned by TPTB, just like all media presstitutes. Zeig Heil!!!

Thu, 04/17/2014 - 18:18 | 4671070 LooseLee
LooseLee's picture

Sad (and shameful), but they eventually will be selling shares to remain solvent...

Thu, 04/17/2014 - 19:20 | 4671237 The_Dude
The_Dude's picture

They do it as financial planning step when credit is available cheaply but there are no prospects for return on invested funds on value add opportunities (R&D, advertising, etc).  This is even more disturbing when you see tech (growth oriented P/E) companies doing this.

 

The entire US economy in a nutshell.  Corp leaders churning cheap paper with no investment in the future for short-term returns and crossing their fingers that they make it out before the SHTF.

Thu, 04/17/2014 - 16:48 | 4670846 RafterManFMJ
RafterManFMJ's picture

OT

Memo to those that place obstructing adverts that I cannot get rid of no matter where I Clik on the X;

Filling my mobile screen and often taking me to your site for a more detailed pitch, causing me frustration and costing me data::

As Christ himself is my witness I will never use your services, and should the opportunity present, I'll deposit a peanut shit in your mouth.

PS Fuck You.

Thu, 04/17/2014 - 17:00 | 4670867 NotApplicable
NotApplicable's picture

I know your pain. If I start to see that stupid Schwab ad come up on my iTouch. I just start reloading until a different ad replaces it.

The other thing I do is to always try and stop the page from loading before those bastards pop up.

It seems Steve Jobs couldn't protect me from all of the evils of the net.

Thu, 04/17/2014 - 17:01 | 4670869 DoChenRollingBearing
DoChenRollingBearing's picture

 

 

+ 1  Spot on.

I once did buy from an advertiser here at ZH (custom-decorated flash drives), their ads were discrete and unobtrusive.

Thu, 04/17/2014 - 17:10 | 4670888 NotApplicable
NotApplicable's picture

Lemme guess, you had "free porn" printed on them... loaded them up with Stuxnet... placed them around some factory... then sat back and waited for bearing orders?

Thu, 04/17/2014 - 17:33 | 4670951 Jam Akin
Jam Akin's picture

So beware of DoChen bearing flash drives is the lesson for today?

Thu, 04/17/2014 - 18:13 | 4671059 DoChenRollingBearing
DoChenRollingBearing's picture

 

 

Flash drives for Ameru (rodajes means "bearings", not girlz!):

http://tinyurl.com/av9xkrq

 

 

Thu, 04/17/2014 - 16:57 | 4670863 Sorry_about_Dresden
Sorry_about_Dresden's picture

Always wondered how they keep increasing eps while there revenue shrinks. Great analysis. This will not end well.

Thu, 04/17/2014 - 17:05 | 4670875 arby63
arby63's picture

Okay, new feed but I want to get out a message to "everyday americans" - We are fucked. Times are going to get tough. You think Janet for the Jew Clan at the Federal Reserve will be able to fix shit? HA!HA!HA! No.

 

We are right now on a slow boat to ruin. I suspect we have about 18 months until "middle class" collapse. Sure, many collapses have been predicted or discussed--this is a specific collapse. That's about what is left in the tank America.

 

That's after both Hook and Crook. Shit happens. 

 

And, shit will happen fast. Really fast. Mark my word. Mark the calendar. Pluse/Minus 3-months. America is done. 

 

The .001% may have some bread; however, try and spend it soon. 

Thu, 04/17/2014 - 17:08 | 4670881 NOTaREALmerican
NOTaREALmerican's picture

I think the smart-n-savvy people who run IBM will know what's best for the smart-n-savvy people who run IBM,  they always do.

Thu, 04/17/2014 - 17:13 | 4670893 Rainman
Rainman's picture

I got a hunch the IBM/NSA monkey business is sticking to Big Blue overseas 

http://www.theregister.co.uk/2014/03/25/bruce_schneier_sneers_at_ibms_nsa_denials/

Thu, 04/17/2014 - 17:14 | 4670897 Gamma735
Gamma735's picture

You are going to see lots of US Tech companies suffer until they are no longer willing to be NSA lapdogs.

Thu, 04/17/2014 - 17:32 | 4670950 NotApplicable
NotApplicable's picture

Given that IBM's always been a CIA organization (offices in how many countries, again?), claims about not cooperating with NSA do have merit.

I would just love to see them use this as a defense.

Thu, 04/17/2014 - 17:20 | 4670912 AustrianJim
AustrianJim's picture

whether as a result of Snowden revelations and NSA blowback by BRIC nations, or simply because the global economy is contracting far faster than rigged and manipulated markets worldwide will admit

It was the weather.

Thu, 04/17/2014 - 17:26 | 4670926 forwardho
forwardho's picture

"since the start of 2012 nearly identical amounts have been spent to fund stock buybacks as has been raised through net debt issuance:"

So HAL has a car that is out of gas. He is also broke. Hal goes to the title loan depot and barrows money at 0% intrest to fill his tank. He barrows and drives until the car breaks down and has no value.

As outlandish as this seems, I understand IBM's logic. Without the barrowed cash the company would be dead on the side of the road.

With no money being spent on R&D There will be no future car.

 

 

Thu, 04/17/2014 - 17:29 | 4670934 Fuh Querada
Fuh Querada's picture

why don't they just fudge better numbers, no one would lift a phinger.

Thu, 04/17/2014 - 17:48 | 4670965 buzzsaw99
buzzsaw99's picture

{from the ny slimes} This doesn't make any sense:

When IBM reported fourth-quarter and full-year earnings a few weeks ago, they could have been an excuse for popping champagne corks in the executive suite. That’s because annual bonuses for the company’s chief executive, Virginia Rometty, and her top executives are based on a formula that heavily weights earnings growth, and IBM’s earnings were a record $5.73 a share, up 12 percent. Ms. Rometty stood to collect up to twice her target bonus, or $8 million, on top of her $1.5 million salary and other compensation. “She could have draped herself in the short-term metric of earnings per share and said, ‘Let’s celebrate,’ ” said Jeffrey Sonnenfeld, a professor at the Yale School of Management and founder of the Chief Executive Leadership Institute. Instead, Ms. Rometty announced, “In view of the company’s overall full-year results, my senior team and I have recommended that we forgo our personal annual incentive payments for 2013.”...

Why would they jack up the share price and then not take the bonus? There has to be an angle. A bribe from Icahn't or some other hedge fund maggot? Does. Not. Compute.

Thu, 04/17/2014 - 19:45 | 4671376 falconflight
falconflight's picture

Maybe she's being groomed for a Obama Regime position?

Thu, 04/17/2014 - 17:53 | 4671004 luna_man
luna_man's picture

 

 

Nice reality check...MY MAIN MAN!!

Thu, 04/17/2014 - 17:57 | 4671015 NESD
NESD's picture

IBM is only doing what makes sense given the Fed’s insane policy.  They can sell 10 year debt fixed at 3.6%, deduct the interest as an expense, and buy back stock yielding around 2% where the dividend is not deductible for tax purposes. It is close to a wash financially now and a probably a positive if the dividend can be raised in the future. In adding leverage to the balance sheet they are simply substituting interest at a known fixed rate for dividends with a variable but historically rising rate. Cash out for combined dividends and interest is little different adjusted for tax benefits.

The reason IBM capex has reached a plateau is because they have sufficient capacity needed to provide the goods and services their customers require.  At a certain point it makes no sense to invest in additional capacity for mainframes when there is no incremental demand for same. Same thing for their services unit.  And so it goes for many mature companies reaching terminal growth in their core competencies.  What better place to put cash than shareholder friendly actions?  Squander it in some perceived growth area they know nothing about?  IBM stock buybacks make sense but the magnitude of debt issuance does seem excessive for a no/slow growth business even with Fed giving an incentive to add leverage to the balance sheet.

Thu, 04/17/2014 - 18:31 | 4671105 GooseShtepping Moron
GooseShtepping Moron's picture

Thanks for that well-written comment.

But by that logic, IBM, no longer prioritizing its core competence, is steadily ossifying into a prop desk that happens to run a small computer business on the side; and the same could said, mutatis mutandis, for most other mature firms - another unfortunate side effect of the financialization/economic repression of the dying West.

 With that said, perhaps it's time to carefully consider the ethics of allowing zombie companies to survive when there is no longer any demand for their ostensible product. These firms are no longer providing a service; they have, in effect, become like pirate ships plying the troubled waters of a country in distress, existing solely to further their own existence. Does this not merit the same remedy which in ages yore was applied to pirates of the traditional stamp?

Thu, 04/17/2014 - 18:01 | 4671026 Youri Carma
Youri Carma's picture

The Great Stock Buyback Craze Is Finally Ending - With Big Blue as Big Example

Thu, 04/17/2014 - 18:02 | 4671032 alexromanl
alexromanl's picture

I believe IBM will take the ratings downgrade (what is the bps penalty for a couple of notches these days, 50 bps on a 10y issuance?) to continue ramping share repo until they can't muster enough cash or their debt issuances fail (i.e., less than 1.5x oversubscribed).  Rating agencies are asleep at the wheel on this one, waiting for the next organic growth wave to come -- it takes balls to downgrade all-might IBM.  Many companies have taken this path since the financial crisis, with cheap debt readilty available (investors hungry for yield gobble this stuff up) and compensation packages based on shares.  It is easy to forego the annual incentive plan when your long-term payout just got juiced up.  Check out the proxy statement for more details on managerial compensation, all the truth is there. 

Also, don't forget the issue about taxes.  How much of IBM's cash can be "repatriated" to the US without hurting the EPS targets that IBM has guided investors to?  Everything is interrelated in the end...

Thu, 04/17/2014 - 18:24 | 4671080 LooseLee
LooseLee's picture

Organic growth? Are you serious?

Thu, 04/17/2014 - 18:26 | 4671086 Waterfallsparkles
Waterfallsparkles's picture

Yep.  To cover earnings shortfalls they have to buy back shares to divide the earning with fewer shares.  Just a scam.

Thu, 04/17/2014 - 20:06 | 4671437 ArmyofOne
ArmyofOne's picture

Debt dosen't matter when any insolvency is just another bailout away. 

Fri, 04/18/2014 - 04:30 | 4672366 guasilas
guasilas's picture

  Amazing that management is not in jail.

Share buybacks use shareholder's money to provide a put option to those who do not wish to be shareholders anymore, generally managers getting rid of their cheap options without hurting the share price and so their profit.  As for the "reduced share number that increases earnings per share", in this case, it is in fact forcing remaining shareholders to own a larger share of debt.

  As swindles go, share buybacks is up there with sub primes and flash trading.

Fri, 04/18/2014 - 06:07 | 4672402 Not Goldman Sachs
Not Goldman Sachs's picture

Dave, Dave, Dave,  you left out another factor that WILL allow continual can -kicking....the ratings agencies. They are corrupt as well, therefore will continue aaaaaaaaa+++++++ for IBM despite deteriorating debt/equity conditions. One should not overlook/forget their track record in the big scam!

Sat, 04/19/2014 - 15:10 | 4675865 soopy
soopy's picture

IT'S THE GREAT RESET, TYLER BROWN!

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