Stockholders Got Plundered In IBM’s Hocus-Pocus Machine

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I’m not picking on IBM. I’m almost sure they have some decent products. So they had a crummy quarter – the sixth quarter in a row of sales declines. And their hardware sales in China have collapsed since Snowden’s revelations about the NSA and its collaboration with American tech companies. But in one area, IBM excels: its hocus-pocus machine.

IBM isn’t alone in its excellence and isn’t even at the top of the heap in that respect. There are many corporations like IBM, mastodons that successfully pull a bag over investors’ heads, aided and abetted by Wall Street with its “analysts,” and by the Fed, to hide the stockholder plunder taking place behind a billowing smokescreen of verbiage.

CFO Mark Loughridge put up that smokescreen himself, right in front of everybody, during the earnings call. “We’ve returned just over $11 billion to shareholders this year,” he said. “We paid out $3 billion in dividends and spent over $8 billion and grow share repurchases to buy back almost 40 million shares.

That’s the smokescreen. Behind it, IBM, incapable of keeping its revenues from withering, has been on an acquisition binge, gobbling up companies left and right, hoping to get its hands on technologies and revenues that would cover up the decline of its own revenues. So far this year, IBM lists eight “selected acquisitions.” In 2012, IBM spent $3.7 billion on 11 acquisitions. Since 2000, IBM acquired about 150 companies.

During this acquisition binge, IBM has been massively overpaying, but it doesn’t matter to IBM because it’s paying either with its own freshly printed stock, of which it can print an unlimited amount, or with borrowed money, of which it can get a nearly unlimited amount for nearly free, thanks to the Fed’s QE and zero-interest-rate policies. And even if it says it used “cash” for the acquisition, eventually, IBM will sell bonds to fill the hole.

The amounts IBM overpaid for its acquisitions end up in Goodwill and Intangible Assets. These are expenses that have been paid, either in cash or in stock. By dint of our ingenious accounting system, these expenses have not hit the income statement, and earnings, yet. Instead, they’ve been parked on the balance sheet as a harmless-sounding asset – to be expensed at a later date. Analysts will shrug it off as “noncash charges.” True, the act of writing them off is noncash. But they were paid for with hard cash or real stock, now down the drain.

By September 30, Goodwill and Intangible Assets had ballooned to $34.9 billion! Almost 30% of its Total Assets of $117.8 billion. It also had $97.8 billion in liabilities. That left $20 billion in stockholder equity. Once Goodwill and Intangible Assets (future expenses!) are taken out, it leaves the hapless stockholder with a “tangible equity” of a negative $14.9 billion.

If that happened to homeowners, they’d be “upside-down” or “under water,” meaning that they owed more on the house than the house was worth. The house itself has value, but the owner doesn’t own any of the value. The value belongs to the bank. IBM stockholders are in the same position as under-water homeowners. IBM is a valuable company – for executives, bondholders, lenders, target companies, and others, but not for stockholders. They’ve been plundered.

And that hole is getting relentlessly deeper. IBM started 2011 with $23.2 billion in Total Equity – $3 billion more than today. After subtracting Goodwill and Intangible Assets of $28.6 billion, tangible stockholder equity was a negative $5.4 billion. Since then, the hole has nearly tripled!

Mr. Loughridge spoke passionately of the “over $8 billion” IBM spent in the third quarter “to buy back almost 40 million shares” to create “value” for shareholders. What a smokescreen these words were!

So far in 2013, IBM spent $14.2 billion to repurchase 72 million shares. In 2012, it spent $12 billion on 61 million shares. In 2011, it spent $15 billion on 89 million shares. Since January 1, 2011, IBM spent $41.2 billion to buy back 222 million shares. But the math doesn’t quite work out….

On January 1, 2011, there were 1.228 billion shares outstanding; on September 30, 1.098 billion shares: IBM lowered the share count by 130 million shares – not 222 million. What happened to the remaining 92 million shares it bought back?

At the prevailing price over the period, that’s a cool $17 billion in cash.

Those were shares that IBM issued for executive compensation and acquisitions during that time and then turned around and bought them back. In the process, $17 billion changed ownership, from IBM stockholders to the executives of IBM and to the owners of the acquired companies.

That’s the hocus-pocus machine. Only 58.6% of the cash IBM spent on share repurchases served the purpose IBM claimed, namely reducing the total number of shares outstanding and creating “value.” The remaining 41.4% served to fatten the paydays of IBM executives and the owners of companies that were acquired with stock. So that these 92 million shares wouldn’t chop EPS every quarter – for example, in Q3, EPS would have been 8.4% lower – and to keep the scheme from the public, IBM blew $17 billion.

After 102 years of existence, IBM is a financial skeleton, held upright by low-cost debt, and by the Fed that makes that low-cost debt available. If the Fed steps away from its easy-money policies, or if credit freezes up even for a short time, that prop will collapse, and stockholders will discover to what extent they’d been plundered. To avert that fate, IBM’s CEO will have to call up the Fed and beg for a bailout, such as it happened for numerous of our corporate heroes, including GE, during the financial crisis.

When IBM confessed on Wednesday that hardware sales in China had collapsed, every word was colored by Snowden’s revelations about the NSA’s collaboration with American tech companies, from scrappy startups to mastodons like IBM. Read…. NSA Revelations Kill IBM Hardware Sales in China.

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