Buyback Of Stocks By Ibm

FINANCIAL MANAGEMENT I TERM PROJECT

Course Instructor

Dr. Kanwal Misra

Submitted by Abhimanyu Singh Amal Mohan Astha Chaturvedi Deeptodip Sen Sudhanshu Kumar

01 04 13 19 43

1. Introduction: This study aims to find the impact of repurchase of stocks by a company. We have chosen IBM as an example of it. In May, IBM repurchased $12.5 billion of its common stock from three banks through accelerated share repurchase agreements which concluded at the end of February 2008.

1.A. Methodology: We are following a structured way to analyse the impact of repurchase beginning with the reasons to repurchase. The steps followed have been listed below: 1) Selection of live example of a company which has done this exercise in the past. 2) Highlighting the need for repurchase by this company 3) Major reasons of repurchase 4) The financial condition of the company before the repurchase 5) The financial condition of the company after the repurchase 6) Market implications 7) Conclusion

1.B. Reasons for repurchase 1) When a company feels that the exchange has discounted the price of its share by a larger than expected value, the company goes for a repurchase. 2) Improved financial ratios namely ROA, ROE, EPS and P/E ratio. However it’s the by product of the first motive. 3) To avoid dilution 4) They are subjected to lower capital gains tax rate. 5) To integrate all sister companies less than one umbrella—as is the reported case of iGATE.

After the initial study of the balance sheet of the IBM for the past three years it can be observed that the companies Treasury stock has grown year by year. Year

2008

2007

2006

Treasury Stock

(63,945,000)

(46,296,000)

(38,546,000)

According to Samuel J Parmesan, chairman, president and chief executive officer, IBM, "These stock repurchases are enabled by IBM’s strong, consistent cash flow and are an important way of returning value to IBM shareholders. The IBM repurchase seems to be driven by the reason number one listed above. The financial ratios show an improving trend superficially. This is in line with the company policy as communicated by its chairman. The detailed analysis will be the part of this whole exercise.

2. Company profile-IBM at a Glance: International Business Machines Corporation, abbreviated IBM and nicknamed "Big Blue" (for its official corporate colour), is a multinational computer technology and consulting corporation headquartered in Armonk, New York, United States. The company is one of the few information technology companies with a continuous history dating back to the 19th century. IBM manufactures and sells computer hardware and software, and offers infrastructure services, hosting services, and consulting services in areas ranging from mainframe computers to nanotechnology. The company which became IBM was founded in 1896 as the Tabulating Machine Company[9] by Herman Hollerith, in Broome County, New York (Endicott, New York, where it still maintains very limited operations). It was incorporated as Computing Tabulating Recording Corporation (CTR) on June 16, 1911, and was listed on the New York Stock Exchange in 1916.

3. Repurchases history of IBM: Buyback is not new to IBM.It has done this from time to time. There are many instances where the company has exercised this option. This is one of the philosophies of this organisation to retain the market value of its shares.

3.A. Buyback of 1998: When asked why IBM is spending money on stock buybacks, a company spokesperson, John Bukovinsky, said: "IBM buys back shares in part because it generates so much cash from operations and has little need to build new plants. Most of our sales growth now comes from computer services, and that takes less investment than building the machines themselves."He continued: "We assume a gross profit decline of about one per cent a year, primarily as a result of the changing mix in the products and services we sell. As services become the greater portion of the business, we believe the gross profit decline will be offset by improvements in the tax rate and the tax structure. As a result we will be able to maintain a net profit of about seven per cent,"

3.B. The motive of 1998 buyback—Negative buyback: As per One vocal critic of Gerstner (CEO) and a long time IBM watcher, Bob Djurdjevic, "They're saying they can't think of a better way to invest in the technology industry. Instead they are paying off Wall Street in exchange for good opinions of IBM stock." As an example, let's examine the latest quarterly results from IBM. The first sentence of the company's press release touted that the earnings per share went from $1.35 in the previous year to $1.56 this quarter. Only in subsequent sentences did IBM point out that profits raised a paltry $100 million from $1.4 billion to $1.5 billion year over year. Revenues were up only eight per cent. In the same release, IBM revealed profits for the nine months ended 30 September 1998 were $4 billion, exactly the same as a year earlier. Sales for the nine months were $56.5 billion, an increase of three per cent compared with $54.8 billion

This was meant to profit the employees, particularly its executives, who have the biggest stock options.IBM's CEO sold 142,000 shares for a gain of about $16.6 million. In total Gerstner became worth about $95 million.

3.C. Buyback of 2007—the positive buyback On 29th May 2007 IBM (NYSE: IBM) announced that it repurchased $12.5 billion of its outstanding common stock through accelerated share repurchase agreements. Under the agreements, IBM repurchased 118.8 million shares, or 8 percent of the outstanding shares of common stock as of May 29, for an initial price of $105.18 per share. The shares were purchased from three banks under accelerated share repurchase agreements, which provided IBM with immediate delivery of the shares. The banks were expected to purchase an equivalent number of shares in the open market during the next nine months. The initial price of the accelerated share repurchases was subject to an adjustment based on the volume weighted average price of the shares during this period. IBM did not plan to make any additional stock repurchases during this period. The repurchases were executed through IBM International Group, a wholly-owned subsidiary of IBM, with $1 billion in cash and $11.5 billion borrowed through a loan agreement with a number of financial institutions. Principal and interest on the loan were paid with cash generated by IBM International Group’s non-U.S. operating subsidiaries. The repurchases were part of the $15 billion authorization for the company’s stock repurchase program approved by the IBM board of directors on April 24. After executing the $12.5 billion repurchases, the company had approximately $1.8 billion remaining from this authorization. IBM expected 2007 earnings per share growth of 13 to 14 percent, compared with the 11 percent estimate the company provided during its first quarter earnings report. Thes e estimates excluded the gain from the previously-announced sale of its printer business. The current estimate reflects the benefit of two to three points of growth, or approximately 14 to 17 cents of earnings per share, from the accelerated share repurchases.

4. The buyback phenomenon Stock repurchase is a program in which a company buys back its own shares from the marketplace, reducing the number of outstanding shares. This is usually an indication that the company's management thinks the shares are undervalued. A maximum dollar amount of shares to be repurchased is authorized while repurchasing by the company’s board of director. Just like any investor, the company will buy shares when the price is right. A treasury stock is used to hold the repurchased shares.

5. General Reasons for repurchase Firstly, buying back of some of the shares increases the company's earnings per share. Since, there will be a smaller number of shares over which the earnings will be distributed; the earnings per share will increase. Secondly, a stock-repurchase is an indication of excess cash available with the company. Using this excess cash when a company repurchases its own stock because may be the company may feel that the current price of the share is less then what it should be. This sends a signal to investors that the company thinks its own stock is the best investment it could make. When the company buys back its own stock, it might be because the company wants to invest in other securities or capital investments. So, the third reason for a stock-repurchase program can be to acquire shares for management and employee incentive plans, including stock options and stock-purchase plans, or other qualified retirement plan. Lastly, company may have a plan to expand its business through mergers and acquisitions. So, the stock-repurchase plans aim to build currency for acquisitions. A company would increase its amount of treasury stock so that it could use those shares to acquire another company. For this reason, a stock-repurchase program could be considered a sign of growth.

6. Need for Repurchase--IBM buyback Generally, company stock-repurchase plans are good news for investors. Stock repurchases can be a sign that a company is financially healthy. Thus a buyback program also often results in an increase in the price of the stock. This study aims to find the impact of repurchase of stocks by a company. IBM has been chosen as an example of it. In May, IBM repurchased $12.5 billion of its common stock from three banks through accelerated share repurchase agreements that concluded at the end of February 2008. As stated by IBM, it has always believed in giving good returns to its investors. To do so, the company keeps on repurchasing its shares so that it can give good dividends. Al so, the market price of the shares increases by such practice.

7. Pre purchase and post purchase analysis 7.A. Ratio Analysis As we know the stock repurchase of IBM was completed between 2007 and 2008. The ratios of the two years indicate the implications. The balance sheet of the company is shown in Exhibit 1 and the income statement for the corresponding year is shown in Exhibit 2.These data has been used to calculate various financial ratios which has been shown in Exhibit 3.

Exhibit 1-Balance sheet of IBM Period Ending Assets Cash and Short Term Investments

FY2008

FY2007

FY2006

FY2005

FY2004

12.91 B

16.15 B

10.66 B

13.69 B

10.57 B

Net Receivables

28.79 B

26.85 B

24.43 B

28.14 B

28.92 B

Total Inventories

2.66 B

2.81 B

2.84 B

3.32 B

2.94 B

0

0

0

0

0

2.61 B

2.38 B

—

—

—

Other Current Assets

36.10 B

5.58 B

4.35 B

4.71 B

5.12 B

Current Assets Total

49.00 B

53.18 B

44.66 B

45.66 B

47.14 B

Long Term Rec eivables

11.60 B

10.07 B

9.63 B

10.95 B

11.10 B

271.00 M

416.00 M

456.00 M

550.00 M

560.00 M

1.67 B

1.43 B

918.00 M

566.00 M

1.13 B

14.30 B

15.08 B

14.44 B

13.76 B

15.18 B

Property, Plant & Equipment Gross

38.58 B

36.52 B

34.26 B

36.38 B

37.12 B

Accumulated Depreciation

23.50 B

22.08 B

20.50 B

21.21 B

22.43 B

Other Assets

46.22 B

37.12 B

28.34 B

33.50 B

31.95 B

Deferred Charges

19.11 B

11.86 B

21.43 B

20.97 B

18.81 B

Tangible Other Assets

1.61 B

1.42 B

964.00 M

756.00 M

569.00 M

Intangible Other Assets

16.39 B

15.06 B

11.10 B

10.23 B

8.64 B

109.52 B

118.92 B

99.35 B

103.92 B

106.33 B

12.24 B

8.90 B

7.22 B

8.10 B

6.65 B

Accrued Payroll

4.64 B

4.60 B

3.32 B

3.80 B

3.67 B

Income Taxes Payable

3.67 B

4.67 B

4.71 B

4.73 B

5.48 B

—

—

—

—

—

Other Current Liabilities

15.70 B

13.96 B

12.55 B

13.71 B

13.37 B

Current Liabilities Total

31.20 B

44.31 B

40.09 B

35.15 B

39.79 B

Long Term Debt

23.04 B

13.78 B

15.42 B

14.83 B

16.99 B

13.58 B

13.55 B

13.78 B

15.88 B

14.83 B

Progress Payments & Others Prepaid Expenses

Investment in Unconsolidated Subsidiaries

Other Investments Property, Plant & Equipment Net

Total Assets Liabilities Short Ter m Debt & Current Portion of Long Term Debt

Dividends Payable

Provision for Risks & Charges

Deferred Taxes

-449.00 M

-3.22 B

-216.00 M

-2.90 B

-2.45 B

3.06 B

2.50 B

2.44 B

2.22 B

1.84 B

—

—

—

—

—

Other Liabilities

64.86 B

6.91 B

4.14 B

4.24 B

4.83 B

Total Liabilities

96.06 B

90.45 B

70.85 B

70.82 B

74.64 B

Non-Equity Reserves

0

0

0

0

0

Minority Interest

0

0

0

0

0

Preferred Stock

0

0

0

0

0

Common Equity

13.46 B

28.47 B

28.51 B

33.10 B

31.69 B

Common Stock

412.00 M

402.00 M

396.00 M

393.00 M

387.00 M

Capital Surplus

34.78 B

30.87 B

28.53 B

26.28 B

15.88 B

0

0

0

0

0

-7.17 B

-11.85 B

-4.23 B

-4.52 B

-3.45 B

—

—

—

—

—

Retained Earnings

60.64 B

52.43 B

44.73 B

38.15 B

37.52 B

Equity in Untaxed Reserves

—

—

—

—

—

ESOP Guarantees

0

0

0

0

0

3.43 B

2.82 B

2.15 B

2.41 B

1.55 B

325.00 M

119.00 M

67.00 M

50.00 M

5.00 M

Treasury Stock

63.94 B

46.30 B

38.55 B

31.07 B

24.03 B

Total Liabilities & Shareholder’s Equity

109.52 B

118.92 B

99.35 B

103.92 B

106.33 B

1.39 B

1.51 B

1.57 B

1.65 B

1.69 B

Deferred Income Deferred Tax Liability in Untaxed Reserves

Shareholders Equity

Revaluation Reserves Other Appropriated Reserves Unappropriated (Free) Reserves

Unrealized Foreign Exchange Gain (Loss) Unrealized Gain (Loss) on Marketable Securities

Common Shares Outstanding

Exhibit 2-Income statement for IBM Period Ending

FY2007

FY2006

FY2005

FY2004

103.63 B

98.79 B

91.42 B

91.13 B

96.29 B

57.97 B

52.26 B

48.57 B

49.88 B

56.34 B

5.20 B

4.98 B

5.19 B

4.92 B

4.70 B

Gross Income Selling, General & Admin Expenses

45.66 B 27.50 B

41.33 B 25.66 B

37.87 B 24.93 B

36.07 B 24.70 B

35.03 B 22.04 B

Other Operating Expense

0

0

0

0

0

5.90 B

5.37 B

5.23 B

6.54 B

6.88 B

Operating Income Extraordinary Credit - Pretax

15.94 B 0

13.83 B 0

11.14 B 0

10.33 B 0

Extraordinary Charge - Pretax

700.00 M 565.00 M 0

289.00 M 536.00 M 0

12.21 B 775.00 M 2.52 B 307.00 M 0

717.00 M 180.00 M —

513.00 M 152.00 M —

—

—

—

—

—

1.45 B

1.40 B

1.14 B

2.22 B

1.01 B

17.39 B

15.10 B

13.60 B

11.92 B

10.81 B

673.00 M 9.00 M 16.72 B 4.38 B 1.23 B

620.00 M 11.00 M 14.49 B 4.07 B 613.00 M 1.56 B

289.00 M 16.00 M 13.32 B 3.90 B 86.00 M

Net Sales/Revenues Cost of Goods Sold (Excluding Depreciation) Depreciation, Depletion and Amortization

Operating Expenses - Total

Non-operating Interest Income Reserves Inc (Dec) Pretax Equity in Earnings Other Income/Expenses - Net Earnings Before Interest & Taxes (EBIT) Interest Expenses On Debt Interest Capitalized Pretax Income Income Taxes Current Domestic Income Tax Current Foreign Income Tax

FY2008

2.10 B

1.44 B

236.00 143.00 M M 4.00 M 15.00 M 11.70 B 10.67 B 3.71 B 3.17 B -645.00 280.00 M M 2.02 B 1.86 B

Deferred Domestic Income Tax Deferred Foreign Income Tax

664.00 M 76.00 M

1.52 B

1.99 B

1.75 B

191.00 47.00 M M — — 0 0

522.00 M 604.00 M — 0

Income Tax Credits Minority Interest

— 0

200.00 M — 0

Equity in Earnings After Tax Income Expense

— 0

— 0

— 0

— 0

— 0

Discontinued Operations

0

0

12.33 B

10.42 B

-18.00 M 7.97 B

—

Net Income Before Extra Items/Preferred Div Extra Items & Gain (Loss) Sale of Assets Net Income Before Preferred Dividends Preferred Dividend Requirements

-24.00 M 9.42 B

0

76.00 M

0.00

12.33 B

10.42 B

-36.00 M 9.49 B

7.93 B

-30.00 M 7.48 B

0

0

0

0

0

Net Income Available to Common

12.33 B

10.42 B

9.42 B

7.93 B

7.48 B

7.48 B

The first thing that is evident from the table is that the shareholders’ equity has reduced in 2008. This is the first direct result of the stock repurchased. From the data we also see that the ROA has increased to 11.26% from 8.65%. This is mainly on account of the decrease in cash with the company, as the cash has been spent to buy back the stock from the investors. Further, the EPS has increased from 7.18 to 8.93, and Price Earnings ratio has decreased from 15.06 to 9.42. Both of these are desirable and could be some of the goals of IBM while considering the repurchase. However the decrease in P/E ratio is partly accounted for by the 2008 financial crisis, which brought down the market price of the shares.

Exhibit 3 Particulars

2008

2007

2006

2005

Net Income

12,334,000

10,418,000

9,492,000

7,934,000

Shareholders’ equity

13,465,000

28,470,000

28,506,000

33,098,000

Total Assets

109,524,000 120,431,000

103,233,000

105,748,000

Market value per share

84.16

108.1

97.15

82.2

EPS

8.93

7.18

6.06

4.91

P/E

9.42

15.06

16.03

16.74

ROE

12.29%

23.64%

27.61%

31.30%

ROA

11.26%

8.65%

9.19%

7.50%

Treasury Stock

63.94 B

46.30 B

38.55 B

31.07 B

Note: All figures in thousands

7.B. Trend Analysis: Dividend is a distribution of value to shareholders. It is believed that during a repurchase plan the company has to offer a price higher than the current stock price to offer incentives to the investors. It can be seen from the graph below that that in the year 2008 when the stocks have been repurchased the dividends has shot up. See exhibit 4.

Period of buybacks—Stock prices shooting up

Exhibit 4

8. Implications: By offering a price higher than the market's, the company is distributing value to its existing shareholders. The main advantage of stock repurchase over dividends is that the latter is a one-time distribution. An increase in dividend is promised to the shareholders, such that the company would be paying the dividend on a regular basis in the future.

5 Years dividend history

Payable Amount/Share 03-10-2009 $0.50 12-10-2008 $0.50 09-10-2008 $0.50

Ex-Date 02-06-2009 11-06-2008 08-06-2008

Record 02-10-2009 11-10-2008 08-08-2008

Declaration 01/28/2009 10/29/2008 07/30/2008

06-10-2008

$0.50

05-07-2008

05-09-2008

04/30/2008

03-10-2008 12-10-2007 09-10-2007

$0.40 $0.40 $0.40

02-06-2008 11-07-2007 08-08-2007

02-08-2008 11-09-2007 08-10-2007

01/30/2008 10/31/2007 08-01-2007

06-09-2007 03-10-2007 12-09-2006 09-09-2006 06-10-2006

$0.40 $0.30 $0.30 $0.30 $0.30

05-08-2007 02-07-2007 11-08-2006 08-08-2006 05-08-2006

05-10-2007 02-09-2007 11-10-2006 08-10-2006 05-10-2006

04/25/2007 01/31/2007 11-01-2006 07/26/2006 04/26/2006

03-10-2006 12-10-2005 09-10-2005 06-10-2005 03-10-2005 12-10-2004

$0.20 $0.20 $0.20 $0.20 $0.18 $0.18

02-08-2006 11-08-2005 08-08-2005 05-06-2005 02-08-2005 11-08-2004

02-10-2006 11-10-2005 08-10-2005 05-10-2005 02-10-2005 11-10-2004

02-01-2006 10/26/2005 07/27/2005 04/26/2005 01/26/2005 10/27/2004

09-10-2004 06-10-2004

$0.18 $0.18

08-06-2004 05-06-2004

08-10-2004 05-10-2004

07/27/2004 04/27/2004

There are two important implications of "expected regular dividend" and "one-time distribution." One is that if a regular dividend is lowered, then investors interpret this act as a bad sign, and thus the price of the stock tends to fall. Because of this built-in expectation, dividend is a burden on the company, as the company feels obligated to satisfy its shareholders' expectation. On the other hand, stock repurchase is a one-time deal, and thus, shareholders don't expect it to continue in any regular fashion in the future.

9. Conclusion: There is a sign of improvement of ratios which helps build investors confidence. The company has been able to keep its growth rate in double digits (12% in economic downturn of 2008).Even though the company has a history of negative buybacks also; buybacks has worked well for the company and the stockholders as a whole.

10. References: [1]

www.EFYtimes.com

[2]

www.VCCircle.com

[3]

www.PRdomain.com

[4]

www.investopedia.com

[5]

www.wikipedia.com

[6]

www.finance.aol.com

[7]

www.yahoofinancials.com