IBM released their quarterly earnings. As is customary, the company announced various financial numbers like how much it earned per share and how much revenue it generated for the quarter, and so on. As is customary for IBM, the company also announced yet another giant share repurchase using shareholder money to buyback IBM shares of stock.
The idea of a stock buyback is that the company figures that its stock is undervalued on the stock market. By buying shares of stock at those low prices, the corporation is increasing shareholder value by making a good investment in itself. Theoretically, those shares repurchased by the company at a low price can be used to pay out earned stock options, for example, at a lower cost.
But, IBM — along with many other companies — has perverted the concept of a share repurchase or stock buyback.
IBM Stock is currently trading near an all-time high stock price. While, it is possible that even at that price per share the company believes its shares are undervalued, that is not what is really going on here.
IBM is not a “new” tech company like Microsoft, Google, Amazon, or Apple where shareholders are accustomed to the company piling up hoards of cash that it has no intention of ever returning to shareholders. Rather, IBM shareholders expect to be paid dividends. This should be true of all shareholders, but the markets have run a long way from reality these days.
For 2009, the company announced that it “returned $10.3 billion to shareholders…”
On the surface, that sounds pretty good. However, what really happened is that the company actually paid $2.9 billion directly to shareholders in the form of dividends and then indirectly returned $7.4 billion to shareholders in the form of IBM stock repurchases.
In other words, that $7.4 billion that was supposedly “returned to shareholders” came not as cash, but as the possible intangible benefits of less shares outstanding.
In certain circumstances the above scenario could be considered a smart fiscal move, or at the very least, a legitimate financial strategy on which reasonable people could disagree.
The problem is that this is not a one-time thing, but rather an ongoing scheme by the IBM Board of Directors and IBM executives who seem to care a lot more about triggering their bonuses than they do about the company shareholders they are supposed to be working for.
IBM has racked up a history of lopsided share repurchases versus dividends. While the company loves to tout how much value it returns to shareholders, looking behind the green curtain reveals some troubling trends.
“IBM’s higher value, higher margin business strategy has enabled the return of $91 billion since 2003 to our shareholders through share repurchases and dividends,” said Samuel J. Palmisano, IBM chairman, president and CEO.
Notice how Mr. Palmisano is very careful to include share repurchases in that number, because otherwise, that statement would be: “IBM’s business strategy has enabled the return of $7.6 billion of shareholder value through dividends.” Sounds far less impressive.
Take a look at just the last three years of IBM’s financials and you’ll see the comical lopsidedness of share repurchases compared to dividends.
- 2009 – Dividends: $2.9 billion — Share Repurchases: $7.4 billion
- 2008 – Dividends: $2.6 billion — Share Repurchases: $10.6 billion
- 2007 – Dividends: $2.1 billion — Share Repurchases: $18.8 billion
From 2007 to 2009, IBM spent $36.8 billion buying its own stock. During the same period, the company paid CASH DIVIDENDS to shareholders totaling just $7.6 billion. In three years, the company spent nearly five times more money buying stock than paying dividends. What did shareholders get for all of that stock buying spending spree?
The weighted-average number of diluted common shares outstanding in 2006 (before this 3-year stock repurchase period) was 1.55 billion shares. After spending $36.8 billion, the average number of shares at the end of 2009 was 1.34 billion.
Add it all up, and IBM spent $36.8 billion to reduce the number shares by 210 million, which is the overall net equivalent of paying $175.24 per share of IBM stock.
Don’t forget that IBM stock never traded higher than $130 per share during that time.
It’s not that the there was no value in all of the IBM stock buybacks. Fewer shares means lower supply and a higher-stock price. It also improves certain financial numbers like P/E ratios and the like. However, one has to wonder how much value can be assigned to those things versus the dollar amounts paid for them, especially compared to the intrinsic value of cash payments.
If IBM had forgone repurchasing stock in 2009 and instead paid that $7.4 billion out as dividends, then shareholders would have been paid an additional $5.52 per share for the year, and there would be 1.34 billion shares outstanding instead of 1.31 billion. How much difference in the P/E ratio is made by having 0.03 billion fewer shares?
Which do you think shareholders would rather have?
Why would IBM pursue a strategy of using much more money to buy stock than to pay dividends when “returning shareholder value?”
The non-cynical answer is that is difficult for any company to cut its dividend. Wall Street likes to punish companies that cut their dividends. This is not an intentional desire so much as a function of stockholders requiring a dividend of a certain size to make an investment in the company’s stock. Thus, when IBM, or any company, cuts that dividend payment, those shareholders sell in order to maintain their desired income.
Increasing the dividend on IBM stock from $0.65 a share to even $1.00, for example, locks the company into paying $1.00 per share dividends regardless of future natural variations in the company’s earnings. Otherwise, IBM becomes one of those stocks with an “unreliable” dividend.
In other words, shareholders would rather get a consistent, but low, payment rather than a high payment that might need to be reduced in the future. Using money to buyback stock is not so obvious, and the company can give many reasons for cutting back on such an expenditure without the stigma of cutting the dividend.
The cynical answer is that the bonuses and payouts for IBM executives and IBM’s Board of Directors are based entirely on the price of the stock. Keeping the price per share high benefits IBM execs much more than paying a high dividend to shareholders does. Ironically, the primary use of all these repurchases shares is to give them back in the form of stock grants and stock options to the same directors and executives setting this financial strategy.
Either way, it seems that shareholders, and the financial media, seem content to swallow IBM’s rosy claims about what a wonderful job it does returning shareholder value without questioning whether even a small percentage of money used to repurchase shares would be better spent paying an increased dividend.
While such a financial strategy’s wisdom could be debated, it seems that there will be no debate, because no one will bother asking the question. Just because MBA courses teach that share buybacks are the same as paying dividends from a balance sheet accounting point of view, does not mean that they are the same thing in the real world.
Image courtesy of Yahoo.com stock charts
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