IBM’s End to Buyback Splurge Pressures Rometty to Boost Revenue

Apr 22, 2014 12:01 am ET

April 22 (Bloomberg) -- International Business Machines Corp. is reducing stock buybacks after an $8.2 billion first- quarter splurge, putting more pressure on Chief Executive Officer Ginni Rometty to reignite sales growth or cut costs to hit her profit targets.

IBM said last week it won’t sustain its rate of share repurchases in the first quarter, when buybacks more than tripled from a year earlier to the most since 2007. The company plans to spend less than $5.8 billion total in the final nine months of this year.

Rometty has kept herself bound to IBM’s targets of at least $18 a share in adjusted earnings this year and $20 next year even as she tries to revamp the company in a shifting technology industry. With sales declining, she had ramped up repurchases, helping her hit projections for earnings per share simply by reducing the number of shares in circulation. Now Rometty must start increasing revenue or reduce expenses further -- or risk missing the profit goals.

“You’ve got a bleak picture ahead if you continue to stick with this EPS guidance,” Nicole Black, a fixed-income analyst at Wells Fargo & Co., said in a phone interview. She has the equivalent of a sell rating on IBM bonds. “You’re not delivering organic internal revenue growth. There is not a lot of fat to be cut.”

IBM should consider using its cash to make more acquisitions that will help it grow, Black said.

Mike Fay, an IBM spokesman, declined to comment.

‘Stunning’ Support

Rometty’s first-quarter buyback bonanza was 41 percent higher than the $5.8 billion estimated by Barclays Plc. The repurchases made up “a stunning” 14 percent of all stock traded in the quarter, Toni Sacconaghi, an analyst at Sanford C. Bernstein & Co., said in a report last week. He said that helped support IBM shares, which rose 2.6 percent in the period, compared with a 1.9 percent gain in technology stocks in the Standard & Poor’s 500 Index.

Even so, IBM reported first-quarter adjusted earnings per share in line with analysts’ projections, suggesting it would have missed their profit estimates if it hadn’t been so aggressive in stock repurchases.

IBM’s sales have fallen from a year earlier for eight straight quarters. Technology customers are relying more on cloud-computing services instead of storing data on site, damping the demand for servers and other hardware.

To cope, Rometty has shifted IBM’s focus to areas like cloud services and big-data analytics. So far, the promise of those growing investments hasn’t been enough to make up for the decline of older businesses.

Broken Model?

“Many investors have asked whether IBM’s financial model is ‘broken,’” Sacconaghi said in last week’s report. “Ultimately we believe it is not, but that the model is increasingly strained, and that IBM risks being tethered to its road map to the detriment to its longer-term financial health.”

Declining sales and rising buybacks have squeezed IBM’s free cash flow, which fell 65 percent from a year earlier to $600 million last quarter. A $1.4 billion increase in tax payments cut into the results, and the company still expects $16 billion in free cash flow this year, up from $15 billion last year, Chief Financial Officer Martin Schroeter said.

Schroeter said IBM will be 38 percent toward its profit goal by the end of June, implying adjusted earnings in the second quarter of $4.21 to $4.39 a share. The average analyst estimate was $4.39 last week and has since dropped to $4.32. While Schroeter reiterated the earnings targets for this year and next year, analysts have grown increasingly skeptical, with the average estimate dropping below IBM’s forecast for both years.

Balance Sheet

The repurchases, meanwhile, have taken a toll on IBM’s balance sheet.

Total debt climbed to $44 billion in the first quarter, up from $33.4 billion a year ago. IBM had a cash balance of $9.7 billion at the end of the period, down $1.4 billion from December.

During the first quarter, IBM issued $4.5 billion of new bonds, clearly used to fund buybacks, Black said. The sale included $2 billion in 3.625 percent, 10-year bonds, which paid 95 basis points more than similar-maturity Treasuries at the time, a wider spread than the extra 83 basis points of yield IBM garnered six months prior.

Credit Ratings

Those higher borrowing costs signaled that IBM’s perceived creditworthiness had deteriorated. The company’s debt leverage has creeped up to a ratio of 1.5 times earnings before interest, taxes, depreciation and amortization, which may make its credit ratings more susceptible to a downgrade, Black said in a research note last week.

Moody’s Investors Service has an Aa3 rating on IBM, the fourth-highest investment grade. Standard & Poor’s gives the company a similar AA- rating. Richard Lane, a Moody’s analyst, and Ed Sweeney, an S&P spokesman, didn’t immediately respond to requests for comment on their IBM ratings.

“The company tapped the bond market five different times last year, then you have a pretty sizable February issuance,” Black said in the interview. “I feel like there is investor fatigue on the name.”