In my previous articles, I invited the readers to do some dirt-digging and calculation and see how IBM's performance stack up to the Oracle's expectation. Today I will share my thoughts and findings, as we are in the 18th quarter since Berkshire's initial purchase of IBM, close to the five-year mark.
The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock.
Since 2011, IBM has added more than $13 billion in debt. We have to note that some of the debt went to the global financing division to finance the receivables. So what did IBM do with the debt? From 2011 to 2014, IBM generated about $54 billion free cash flow (Operating CF - capex - net acquisition) but returned $64 billion to shareholder through dividend and buybacks. Obviously, the deficit is financed by debt. Raising debt to buy back shares or to pay dividend is no easy math. I won't go in depth for the sake of this discussion.
At the end of 2010, IBM has almost 1.29 billion shares outstanding. Today it's about 955 million. This is indeed very aggressive.
Naturally, what happens to the company's earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. We should wish for IBM's stock price to languish throughout the five years. Let's do the math. If IBM's stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%. If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the "disappointing" scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $1.5 billion more than if the "high-price" repurchase scenario had taken place.
IBM's earnings, unfortunately, have not met Buffett's expectations so far. In 2011, IBM earned $21 billion pretax. This year IBM is likely to earn about $18 billion pretax. However, a declining IBM stock price has benefited Berkshire in the forms of higher ownership and higher owner's earnings. The original 63.9 million in 2011 represents about 5.5% ownership. Today, due to the aggressive share repurchase, Berkshire's same 63.9 million shares represents almost 6.7% of IBM's ownership.