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THE WALL STREET
JOURNAL. |
Business
Does IBM Love
or Hate Itself?
Stock Buybacks Make
Firms Look Attractive, but Also Deprive Them of Capital for Real
Investment
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By
Dennis K. Berman |
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Updated
Jan. 21, 2014 4:27 p.m. ET
There is a
rare type of organism that eats itself alive. One of them is
International Business Machines
Corp.
For the
past 20 years, IBM has been an avid, methodical buyer of its own
stock. In 1993, it had 2.3 billion shares outstanding. Today it has
1.1 billion, shrinking at more than 1% per quarter over the past few
years. At that pace, there will be no more publicly traded IBM shares
left by 2034.
Rejoice!
You might regard all this buying as good news for shareholders.
Buybacks push up earnings per share. They flaunt management's
confidence in the future. And they are a reason why retail investors
have held on so lovingly to IBM stock.
Look
deeper at IBM and dozens of mature U.S. companies, and you can sketch
a different, more ominous, story: That CEOs are in fact stuck,
reluctant to build new plants, launch products or pursue an
acquisition.
By rote
and by fear, they are pitching their billions into buybacks, nearly $1
trillion from the 100 largest companies in the S&P since 2008. In the
12 months ending in September, the total dollar amount of all
corporate buybacks increased by 15% from a year earlier, according to
S&P Dow Jones Indices.
Cheap
money from the U.S. Federal Reserve helps sweeten this deal. And one
can't underestimate the threat from shareholder activists, who now
patrol the market like prison guards with billy clubs. Overspend and
get whacked.
Other
investment just hasn't materialized at the same rate. Among the entire
S&P 500, the median change in capital spending is 16.7% over the past
five years, based on a screen of stocks using Capital IQ data.
The danger
is that those buybacks have been substituting for substantive future
investment, be it software engineers, new products, or extra
marketing.
This has
two effects: It stymies the economic growth originally intended by the
Fed. And it could eventually leave businesses ill-equipped to adapt to
changes in their industries, especially technology-intensive ones.
Hewlett-Packard Co. pumped
tens of billions into (high-price) buybacks from 2003 to 2011 and is
now is struggling to find its way.
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For the past 20 years, IBM has been an avid, methodical buyer of
its own stock. Bloomberg News |
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IBM
competitor
Amazon.com Inc., meanwhile,
continues to pour in big dollars into actual technology. It grew its
capital spending 14-fold since 2008, and R&D spending fivefold.
Investor
Jim Chanos is starting to worry about just this problem. As one of
Wall Street's best-known short sellers, he's quietly been building an
investment thesis around the idea that buybacks are a sign of
corporate weakness, not strength.
Mr. Chanos
shared his analysis with me from a bright conference room in his
Midtown Manhattan office. We were both left agog at what the numbers
seem to show about how companies are allocating their dollars. Can
this really be right?
By his
count, for instance, the recent return on IBM's buybacks is about
6.5%. Not a terrible number. But IBM's return on what he dubs its "net
business assets"—actual stuff used in actual business—is far better.
It is 18.1%.
Wouldn't
this be a sign to immediately raise investment and shrink buybacks?
Maybe IBM
has concluded there is no better place to put its money. Or that it is
simply doing what stockholders want. It is hard to tell.
"Our
capital allocation model drives reinvestment in the business through
R&D, capital expenditures, and acquisitions, it pays the dividend
every quarter since 1916, and it returns excess capital to
shareholders through share repurchase," said IBM spokesman Michael
Fay. "We can do both, invest and return cash, and we do."
IBM is no
outlier.
Honeywell International Inc.
has been earning about 3.8% on its buybacks, according to Mr. Chanos's
numbers, compared with 13.4% on business assets. Honeywell spokesman
Robert Ferris said the company's total return—which combines
share-price appreciation and dividends—had outpaced its peers and the
broader S&P 500 over the past decade. During that stretch, Honeywell
has split cash flows roughly in two—between business investment and
returns to shareholders, Mr. Ferris said.
Oracle Corp.'s numbers also
showed a large split, between 4.8% return on buybacks and 32.1% on
assets. Oracle declined to comment.
"Corporate
CEOs, with their massive share-buyback programs are in effect
investing in the stock market rather than in expanding business
opportunities at their companies," said Mr. Chanos. "Either they
expect higher returns from the market, or lower returns in their
business, or some combination of both. Given their questionable track
record in timing the market, this may be a cause for concern."
Mr. Chanos
said he was shorting stocks based on this thesis. He wouldn't specify
which ones.
As for
IBM, buybacks still rule. It has raised the amount in recent years and
since 2007 has spent $60.4 billion. The company just made
announcements about new investments in data centers and its Watson
analytics product. But annual capital spending and research and
development have been roughly flat for nearly a decade, between $10
billion and $11 billion.
Many on
Wall Street are now beginning to regard IBM as a company more focused
on its stock price than its long-term path. "Only IBM knows what it
might be forgoing," says
Barclays analyst Ben Rietzes.
But "one can make an argument for organic investments," especially
with revenues shrinking 3% and fresh competition from cloud-computing
competitors.
This
question of investment isn't a conundrum just for IBM. It is for every
CEO protective of his job, unsure about the economy, and fearful of
the activists with the prison-guard eyes.
And so
here it is in 2014, five years since the worst of the financial
crisis. Are they playing to win? Or still playing not to lose?
Write to
Dennis K.
Berman at
dennis.berman@wsj.com and
follow on Twitter:
@dkberman
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