Big Blue is spending billions on buybacks, seeing its stock as undervalued
IBM (IBM) is one of the few big technology companies that has thrived in the economic downturn—and whose stock has surpassed its 2000 tech bubble high. It has done so by jettisoning its low-margin PC business and moving aggressively into services, software, and fast-growing emerging markets. It is the world's biggest computer services provider.
Yet for all its success, perhaps the ripest investment opportunity IBM sees is its own stock. The Armonk (N.Y.)-based company announced on Oct. 26 that it plans to buy back an additional $10 billion of its shares—and has said it plans to spend about $50 billion on buybacks in the next five years. Since taking over as chief executive officer in 2002, Samuel J. Palmisano has spent more than $68 billion on buybacks, about 38 percent of IBM's current market value. Over that time, only ExxonMobil (XOM) and Microsoft (MSFT) have bought more of their own stock. IBM has 1.24 billion shares outstanding, down from 1.72 billion at the beginning of 2003.
Uncertain where to invest and when demand for their products will return, plenty of companies are sitting on cash these days. Their options, besides keeping it in a low-interest account, are to plow it back into the business, disperse it to shareholders in the form of dividends, or buy back stock. What's best for shareholders varies depending on the situation. Increasingly, many companies are deciding to snap up shares. In the second quarter of this year, members of the Standard & Poor's (MHP) 500-stock index bought $77.65 billion of their own shares, up from $24.2 billion in the same quarter last year, though still below the high of $171.95 billion in the third quarter of 2007, according to Howard Silverblatt, senior index analyst at S&P.
Most buybacks are done to offset the issuing of shares via stock options and takeovers, Silverblatt says. Others are meant to aid shareholders by reducing the number of shares outstanding: Remaining shares may be more valuable because they represent a greater claim on the company's earnings. Also, buybacks can help support the share price if the company steps in when shares fall. "If I own the stock and management has a bunch of cash, this is another way for them to make me money," says Daniel Niles, senior portfolio manager at asset management firm AlphaOne Capital Partners.
One objection to buybacks is that companies may overpay, with cash that might be deployed more strategically. From 1986 through 2002, General Motors spent $20 billion on buybacks with money that should have gone to shoring up its finances, says William Lazonick, director of the Center for Industrial Competitiveness at the University of Massachusetts Lowell. In the past decade, Microsoft spent more than $103 billion on buybacks; its stock trades at about half its 2000 high. "A lot of companies are just stupid about buybacks," says Niles. "There should only be one reason you buy back shares: You think they're going up."
At $143.84 on Nov. 2, IBM stock was up nearly 10 percent for the year to an all-time high. Still, David Trainer of New Constructs, a Brentwood (Tenn.) investment research firm, thinks it is undervalued. IBM has steadily raised profits to more than $10 a share, from $3.07 a share in 2002. It has said it aims for operating earnings of $20 a share by 2015. Yet the stock is "trading as if the company's profits will stay the same forever," says Trainer, who bases his analysis on IBM's book value and cost of capital. "Buying back stock is management's way of signaling to shareholders that the stock is cheap." Mike Fay, an IBM spokesman, declined to comment.
Some would like to see IBM use the buyback money on dividends. "The profit is the shareholders' money," says Eddy Elfenbein, who runs the blog CrossingWallStreet.com. IBM's 1.81 percent dividend yield trails the S&P 500 average of 1.92 percent. Microsoft yields 2.34 percent; Intel (INTC), 3.10 percent. "With yields at historic lows and CDs paying nothing," says Joshua Scheinker, a senior vice-president with Janney Montgomery Scott in Baltimore, "everyone wants to see an income stream." Scheinker notes that dividends are taxable—and that the levy may rise if Congress does not extend the Bush tax cuts.
IBM has been careful with its cash. While it has made more than $20 billion in acquisitions since 2002, it has avoided costly bidding wars for trophy companies. Last year it dropped out of the race for Sun Microsystems, which Oracle (ORCL) bought for $7.4 billion. Says Silverblatt: "A company like IBM has enough money in aggregate to give shareholders some of everything: buybacks, dividends, deals."
The bottom line: By committing billions of dollars to its own shares, IBM is saying its stock is undervalued, despite being near a record high.