IBM hollowed out by ‘financial engineering’
Technology company's spending on financial engineering has left it a shadow of its former self
IBM's woes are interesting not simply because they tell us about the economy, but because they reveal broader truths about how, and for whom, firms are run.
IBM kicked its 2015 operating earnings goal off the back of the truck, blaming an outright fall in third-quarter revenues on a sudden downturn in client spending.
"We saw a marked slowdown in September in client buying behaviour, and our results also point to the unprecedented pace of change in our industry," said Ginni Rometty, IBM chairman, president and chief executive. IBM shares fell more than 7 per cent in reaction, giving up more than three years of gains.
It is a firm which did this after five to 10 years of following one of the most popular corporate strategies out there: prioritising financial engineering over investment, and giving primacy to living quarter by quarter rather than for the longer term. The result, and IBM is far from being alone here, is a firm left with a hollowed-out core franchise which has been deprived of investment, combined with higher debt loads.
From 2000 to 2013, IBM pursued an epic campaign of buying back shares, flattering earnings but perhaps at the expense of investment in the future, something which, as a technology company, is promised to no one. During that period IBM spent more than US$108 billion on share buybacks and an additional US$30 billion on dividends. That compares to just US$59 billion on capital expenditure.
Indeed, in the last six years, the firm's debt load has about tripled but sales are essentially flat.
In July, hedge fund manager Stanley Druckenmiller drew a line between that strategy and Federal Reserve policy, which he said encourages firms to stint on productivity improvement and investment in the real economy and instead use cheap money to borrow and buy back shares.
IBM may simply be the victim of market forces as technology evolves, but it is hard to look around the US economy, which has had a combination of very high profit margins and very low capital investment, and wonder if many publicly traded firms are in similarly vulnerable positions.
"In our view, IBM is not different from companies like Cisco, Microsoft, Oracle and Intel," said Eurof Uppington, fund manager at Lombard Odier. "They all face the same sort of pressures from new trends like cloud, mobility and superscale internet and are all reacting in the same way using financial engineering. IBM is probably just early."
The broader unanswered question here is how best to manage a technology company during a period of very rapid technological change. The market tends to assume that company revenues are far more permanent than they actually are. That assumption grew out of 100 or more years of analysing and investing in industrial companies which, while buffeted by war, globalisation and technological change, had the luxury of operating in a more slowly changing world.
That assumption may leave investors today very vulnerable.
A decade of share buy-backs and underinvestment is starting to look like it may have been a mistake.