IBM - International Business Machines

[kevin4u2]

it seems that they're depending upon buybacks to artificially raise earnings

 

As Buffett would say... you can call it artificial, you can call it financial engineering, heck you can call it whatever you want, the effects are real.

[Palantir]

^ No they're not.

[JRH]

^ No they're not.

 

Haha, what? Someone who holds one share of IBM holds a claim on a growing proportion of their future earnings as their share count falls. "Financial engineering."

 

That is not to say anything about the future path or level of earnings, but the above statement is indisputable.

[Palantir]

That's stating the obvious, however, all kevin4u stated was, "the effect is real". Well, which effect is that? Is the company more valuable? No. Is the competitive position any stronger? No. Does the company have strong reinvestment opportunities? No.

 

All you are doing is you're paying out current cash flow to increase your stake in the company. Now is that company worth increasing your stake in? That's the question.

[Guest valueInv]

That's stating the obvious, however, all kevin4u stated was, "the effect is real". Well, which effect is that? Is the company more valuable? No. Is the competitive position any stronger? No. Does the company have strong reinvestment opportunities? No.

 

All you are doing is you're paying out current cash flow to increase your stake in the company. Now is that company worth increasing your stake in? That's the question.

 

Take a look at their stock price over the last 5 years. That's real.

[Palantir]

^ The same argument would refute everything you say in the GOOG thread. Keep it up.

[kevin4u2]

All kevin4u2 did was quote Mr Buffett.

 

You can deny all you want that EPS doesn't increase with a declining share count but that simply isn't true.

 

As for the quality of earnings, that is the debate for every company. However I would note Ibm has huge return on capital and that is why their earnings are of high quality. 2/3rds of the revenue in software and services are described as "annuity like". Lastly, how much capital needs to be continually reinvested? 

 

To go back to the original quote, the effects of share buybacks are real in increasing EPS. 

 

That's stating the obvious, however, all kevin4u stated was, "the effect is real". Well, which effect is that? Is the company more valuable? No. Is the competitive position any stronger? No. Does the company have strong reinvestment opportunities? No.

 

All you are doing is you're paying out current cash flow to increase your stake in the company. Now is that company worth increasing your stake in? That's the question.

[Palantir]

Actually, I take it back, I disagree, economically, EPS does not increase with persistent buybacks. Those earnings are paid out to the selling shareholders, and do not accrue to the shareholders who persist. The economic effect is to drive down real EPS, in the hope that future EPS is higher, the same way a firm reinvests earnings as growth capex.

 

Buffett is wrong.

[Rabbitisrich]

Actually, I take it back, I disagree, economically, EPS does not increase with persistent buybacks. Those earnings are paid out to the selling shareholders, and do not accrue to the shareholders who persist.

 

 

That is not quite true either. From an investor's point of view, the buyback simply moves the role of cash management around, so that it has no effect on a DCF valuation. So the selling shareholders end up with a chunk of cash and a bundle of stocks. The persisting shareholders end up with a bigger bundle of stocks as if the selling shareholders used their cash to repurchase stocks. Economic value is about opportunity costs, so the two scenarios are the same before including liquidity, transaction, and other frictional costs.

[Palantir]

^That is what I'm saying actually. It has no effect on a DCF valuation. Growth due to buybacks is not free and merely an exchange of current cash for future cash.

 

I have had this argument earlier on this same thread...if it pleases kevin4u and JRH they can read those posts.

[Rabbitisrich]

I see, sorry for the misinterpretation. Buffett's references to buybacks at "high" and "low" valuations makes sense from his perspective as someone who has to think about reputational and signaling effects. But people need to realize that if you don't want management to buyback a stock at a high valuation, then you REALLY don't want management to issue dividends at that same valuation, because you get the same negatives, plus an absurd tax rate.

[Liberty]

Palantir, what is your take on Henry Singleton at Teledyne and his buying back of about 80% of the shares outstanding?

[Guest valueInv]

^ The same argument would refute everything you say in the GOOG thread. Keep it up.

 

Big words from a guy who is singing my tunes on Google.

 

Oh and take a look at the multiples on Google and IBM.

[Palantir]

Palantir, what is your take on Henry Singleton at Teledyne and his buying back of about 80% of the shares outstanding?

 

Sorry, not familiar...

[Liberty]

Palantir, what is your take on Henry Singleton at Teledyne and his buying back of about 80% of the shares outstanding?

 

Sorry, not familiar...

 

A great capital allocator to study. One of Buffett's role models.

 

http://www.scribd.com/mobile/doc/98732367

 

http://seekingalpha.com/instablog/315877-the-manual-of-ideas/30189-the-manual-of-ideas-on-business-leader-henry-singleton-founder-of-teledyne-audio

 

 

[Palantir]

I see, sorry for the misinterpretation. Buffett's references to buybacks at "high" and "low" valuations makes sense from his perspective as someone who has to think about reputational and signaling effects. But people need to realize that if you don't want management to buyback a stock at a high valuation, then you REALLY don't want management to issue dividends at that same valuation, because you get the same negatives, plus an absurd tax rate.

 

I agree that buybacks/divs are good when the stock price is low, and the firm is underlevered (AAPL). The investment issue with IBM is twofold IMO - a) Is the business worth investing in? b) Are buybacks a good use of cash?

 

However, if a) is unknown, then "buybacks will grow per share earnings" may not negate that uncertainty.

 

[mcliu]

I see, sorry for the misinterpretation. Buffett's references to buybacks at "high" and "low" valuations makes sense from his perspective as someone who has to think about reputational and signaling effects. But people need to realize that if you don't want management to buyback a stock at a high valuation, then you REALLY don't want management to issue dividends at that same valuation, because you get the same negatives, plus an absurd tax rate.

 

I agree that buybacks/divs are good when the stock price is low, and the firm is underlevered (AAPL). The investment issue with IBM is twofold IMO - a) Is the business worth investing in? b) Are buybacks a good use of cash?

 

However, if a) is unknown, then "buybacks will grow per share earnings" may not negate that uncertainty.

 

From a theoretical perspective, leverage and your considerations in a) and b) do not matter. Whether buybacks are accretive to value depends on if the shares are bought below intrinsic value.

 

If a company's shares are worth $200, but trades at only $100, regardless of whether it's a good business or not, as long as the business purchases and cancels the shares at $100, the transaction will be accretive to shareholders.

 

In IBM's case, if you believe the company's worth $200 per share, and the company is buying back shares at only $170, that definitely creates value for shareholders.

 

Obviously, this share repurchase needs to be measured against other opportunities in the market. If there is a company that's worth $200 but trades for $150, then it's probably better to acquire those shares, than to repurchase stock..

 

Finally, there is an effect on your DCF. If you run a DCF, you'll see that repurchasing shares below intrinsic value is accretive.

[Palantir]

You do not feel "a) Is this firm worth investing in?" is important in the investment decision? Certainly, I see what you're getting at, as long as the firm is buying back below IV, it will be accretive to shareholders. But...how do you know it is below IV? Have you proven that? That will bring us back to the core question - what is IBM worth?

 

I personally do not use Intrinsic value, I prefer to look at a stock based on  the expected FCF yield.

 

 

[mcliu]

You do not feel "a) Is this firm worth investing in?" is important in the investment decision? Certainly, I see what you're getting at, as long as the firm is buying back below IV, it will be accretive to shareholders. But...how do you know it is below IV? Have you proven that? That will bring us back to the core question - what is IBM worth?

 

I personally do not use Intrinsic value, I prefer to look at a stock based on  the expected FCF yield.

 

Whether the firm is worth investing in will be reflected in its intrinsic value. For example, a declining company will have a lower intrinsic value than a growing company. Nonetheless, as long as the market price is below this estimated intrinsic value, any share repurchases are accretive.

 

I mean it's pretty theoretically sound and mathematically-proven.

 

Obviously, in practice, intrinsic value is an estimate, so people with higher intrinsic value estimates believe repurchases add value while those with lower intrinsic value estimates believe otherwise. It doesn't change the fact that whether the IBM's management team is making the right decision to buy back shares, lie in your estimate of intrinsic value.

 

I think you will find that, even if the overall company does not become much bigger (or even if it shrinks), with the right stock repurchases at low valuations, the value of the shares of remaining shareholders will do well.

 

As for IBM specifically, their repurchases will likely offer more value today than most acquisitions in software given the market multiples on those companies. Recent numbers show a struggling top-line, but IBM's long history show a company that's overcome numerous ups and downs.

[Palantir]

Mcliu, you have not proven IBM is below IV, then why are you persisting with the recommendation they buy back stock?

[mcliu]

Mcliu, you have not proven IBM is below IV, then why are you persisting with the recommendation they buy back stock?

 

First of all, in my previous post, I was trying to clarify your misconception that share buybacks do not affect value when in reality it clearly does, depending on whether buybacks are done above or below intrinsic value.

 

^That is what I'm saying actually. It has no effect on a DCF valuation. Growth due to buybacks is not free and merely an exchange of current cash for future cash.

 

Secondly, intrinsic value is an estimate, not something that can be proven. Clearly, your estimate of IBM's intrinsic value is lower than IBM's estimate of their own value, but there's really no way (and no need) to "prove" which estimate is right today. Over time, we will see which IV is the better estimate.

 

 

[Rabbitisrich]

 

 

First of all, in my previous post, I was trying to clarify your misconception that share buybacks do not affect value when in reality it clearly does, depending on whether buybacks are done above or below intrinsic value.

 

 

We may all be talking past each other by using terms differently. I think of intrinsic value as a property of the company, and, generally, distinct from the composition of its shareholder base. So when a company buys back stock, value creation/destruction of intrinsic value does not occur. The investor takes the blame/credit for increasing, maintaining, or shrinking percentage ownership in the company.

 

If you ignore taxes, you can see how a dividend issuance, at undervaluation, is about the same thing as a buyback. In both cases, the action of improving your % ownership is yours. Intrinsic value wouldn't change unless the dividend AND the buyback surprised you. In that case, you would have to adjust your expectations of how management judges opportunity cost. But that is not directly related to the mechanism of buybacks, the value of which mostly results from its tax advantaged status.

 

 

[mcliu]

I think to better clarify, I'm talking about the intrinsic value per share. Indeed the overall value company does not change, but the per share value changes when buybacks occur above/below intrinsic value.

 

Indeed dividends and buybacks are the same in a friction-less market, however, with taxes, buybacks are a more efficient way to return capital. Modigliani-Miller's theorems are pretty clear.

[SpecOps]

The thing is IBM isn't really that interesting based on a DCF valuation either. Compare it to something like Oracle and it seems to be more highly valued.

 

http://seekingalpha.com/article/1787182-ibm-versus-oracle

[prevalou]

if IBM software segment become proportionnaly bigger, margins can expand. Is this the case with Oracle?