Without Growth, Can IBM Still Make Shareholders Happy?
The computing and tech services giant IBM has been promising its shareholders that it would place one goal above nearly all others: To deliver a per-share profit of $20 a year by 2015.
The goal was set by then-CEO Sam Palmisano in 2010, a year when the company earned $11.67 a share. The goal has since been considered a lodestar by his successor, Ginni Rometty, who has consistently nudged the company toward it by seeking to hit one incremental earnings goal after another, quarter after quarter, even during a period when IBM’s overall sales have been on the decline. When it last reported quarterly earnings, IBM reaffirmed its expectation that it will earn $18 a share in 2014 as the final step before the goal.
But as IBM holds its meeting with analysts in New York on Wednesday, whether it can still achieve this goal or if it’s even a healthy goal for the company to strive toward will top the list of concerns for analysts attending the meeting.
Most expect IBM to get there one way or the other, but it’s not going to be pretty, and there are plenty of hurdles. In a research note on Monday, Bernstein Research analyst Toni Sacconaghi said that in order to make $20 a share by 2015, IBM would have to hold its tax rate steady. In 2013, it paid a tax rate of 20 percent, but in 2010 through 2012 it paid 24 percent, making last year seem like an outlier. If the tax rate were to increase to 23 percent, Sacconaghi reckoned IBM would miss its 2015 goal by 60 cents a share without taking some other action to offset the cost.
It has several levers to pull. One of them is share buybacks. IBM has spent more than $13 billion in the last two quarters to buy its own shares and thus reduce the overall number of shares in circulation and boost its share price. Sacconaghi estimated that since 1997 share buybacks have accounted for one-third of IBM’s EPS growth rate of 11.4 percent.
Here’s the problem with those buybacks. IBM has in recent years tended to have easy access to its cash stored outside the U.S. to finance those buybacks by tapping tax credits it has accumulated in countries that have a higher tax rate than in the U.S. Sacconaghi said that by 2015 IBM will have used up most of those credits. Without a tax holiday or a change in U.S. tax policy, Big Blue might lose what has been a big part of its financial playbook.
There are other financial plays it can run, but they, too, are losing their effectiveness. Another backbone of IBM’s profit growth strategy has been to reduce its headcount and to move jobs from the U.S. to other countries. Since 2006, IBM has taken about $8 billion in restructuring charges — nearly $2 billion in the most recent four quarters — to reduce its headcount by a total of about 115,000. (It’s a fuzzy number, as many were likely rehired at lower salaries.) Sacconaghi worries that IBM may have squeezed its workforce about as hard as can be realistically expected. It already boasts the most profitable professional services business. About half are still in the U.S. Over time, IBM could move more jobs — as much of 65 percent of its workforce — outside the U.S.
So what’s with all the financial contortions? Why not just hit the goal the old-fashioned way, through growing the business? That’s unlikely. IBM’s annual revenue had by 2013 dropped by nearly $7 billion from 2011. The one business unit that has seen growth is the $26 billion software business, where growth from 2011 to 2013 has amounted to only four percent.
Hardware sales have been hit especially hard, with sales falling between 12 percent and 26 percent in each of the last five quarters, including a 23 percent drop in the first quarter of this year. The business amounts to what Sacconaghi calls a “material drag” on overall results, and even if it were to stabilize it might not help that much.
Even IBM’s once-revered outsourcing business is losing steam. At $22 billion it amounted to about 22 percent of sales last year, a drop of about eight percent from 2011. It could get worse. Much of the outsourcing business is based on helping customers deploy applications, a business that remains under threat by the transition to applications that require only an Internet connection and a browser to run. IBM is in the business of selling these cloud applications and services, too, but that business accounted for less than $4 billion last year, or less than four percent of sales.
There are still other moves it can make. IBM has been divesting itself of lower-end hardware assets like its x86 sever unit, which it sold to Lenovo for $2.3 billion earlier this year. It is also exploring the sale of other assets including its chip manufacturing business as well as its software-defined networking business. Both could fetch buyers willing to pay in the billions and thus bolster its profits.
All things considered, expect a lot of questions from the analysts in attendance Wednesday about whether IBM can deliver on its goals next year, but not much in the way of specifics of how it intends to get there. Also, don’t expect anything in the way of a new financial goal post-2015. But that’s another story for another day.