IBM is paying Abu Dhabi owned GlobalFoundries $1.5 billion to entice it to acquire IBM’s chip manufacturing division. Yes, that’s right—paying $1.5 billion. So how does IBM make money on deals like this? Volume!
IBM has agreed to pay $1.5bn as part of a deal to shed its lossmaking chip manufacturing arm and avoid the billions of dollars in capital spending it was facing to upgrade its manufacturing technology.
To be clear, it’s not like IBM can’t afford the billions of dollars in capital spending necessary to make its chip manufacturing competitive. The company made $18 billion in profits last year. And it would have reported a $4.7 billion profit this quarter (up from $4 billion in the year ago quarter) had it not been for the $4.7 billion pre-tax charge it took to write off its chip foundry business.
So what is IBM doing with all its money? IBM shareholders will receive roughly $4.5 billion in dividends this year. Meanwhile, the company continues to prop up its share price with stock buybacks—$3.7 billion worth this year, and over $50 billion since 2010.
Yet investing in, you know, making stuff, that’s something that IBM executives can’t be bothered to do.
Next time a righty tells you that we need to cut taxes on corporations and the wealthy so that they can accumulate the capital necessary to invest in creating jobs, send them a link to this.
Peter Lynch, who used to run Fidelity Magellan Fund, used to say that stock buy-backs were a gift to investors because it allowed investors to take capital gains (taxed favorably) rather than receiving dividends, which are taxed at normal everyday marginal rates. It has been used a lot lately as a corporate strategy to boost earnings-per-share and does not necessarily mean much in the way on new potential for the firms who do it.
Libertarian Comment: buyer beware. Stock buy-backs aren’t necessarily good for the long term, particulary if the firm hasn’t had a good growth spurt recently. They could simply mean that management can’t think of better uses of funds other than to artificially increase earnings per share through a buy-back.
What happens when they run out of buy backs capacity? Crash because investors realize the company does not do anything anymore?
@1
Exactly my point. There’s no way that cutting corporate tax rates could spur IBM to invest in creating more jobs when they’re not investing the capital they already have.
Story Time: My father has work at IBM since he got his bachelors in computer science. Back then in ’87 a programmer(not even a engineer) got ~$70k. The blue collar folks got ~$15-20 an hour. My first “real job” at 17 was on the floor, but I was a temp worker through ManPower, and the few directs left were paid less to be our leads. If you had great connections you could be hired direct as an “intern” at $13/hr, but those of us in the unwashed masses got $8.60. So you had a bunch of white grandchildren of VPs working next to poor folks, most of whom were middle age Somali men, doing the same work, but instead of this being a checkmark on their college resumes, this was how they supported their children and relatives. I have worked in manufacturing since, though when I got my degree in Engineering I started at $10k less nominally, and the way that manufacturing collapsed was through the explosion in temp workers and the cutting of mid-level wages. Robots are rare; human labor is required to build things, every screw and sticker on your laptop was put their by someone.
Now Goldy brings this story, but what are we to do when creation of profit from capital expenditures is less desirable than by squeezing labor costs? Such is capitalism, and soon I hope others will start seeing some of this Marxist theory as explanatory for the seemingly idiotic and greedy behavior of those small few who own so much.
It’s not just IBM. HP recently announced that it’s going to split in two (again). Basically they’re doing a “pump-and-dump” on half the company at a time, with most of the proceeds going to the major shareholders who, coincidentally, are the people who decided to do this.
Paying Global Foundar
Paying Global Foundar
Paying Global Foundar
Paying Global Foundries to take this business off IBMs hands would be cheaper than shutting down a business unit in which it was not longer competitive. The fab equipment was no longer suitable for the chips that IBM needs to make. IBM tried to get into the fabless chip business and they could not compete with newer fabs.
The cost to set up a new, modern fab line is huge. People never shut a line to down to refurb it. Because of the way they are constructed, when a line is shut down, it essentially becomes scrap.
Rag on IBM for stock buybacks, but paying GF to take this off their hands was a smart move.
It should be paying back it’s investors, no way it’s going to grow much more. Why the hell would people invest in mature companies if they were not getting income from them?
If it can keep around this level and produce income, I will be happy.
Stock buybacks are better for the economy than parking your cash offshore: Apple, Amazon, Google, etc…
You know who likes buybacks & dividends? Retired folks who live off the investment income. That includes anybody that has an IRA, pension, or annuity. Buybacks allow the income to be taken when the investor wants it, by selling the stock.
I sold my IBM stock last month because the business story isn’t there anymore. (I bought at $77 and sold at $191.) As Goldy says, it’s all financial engineering now. But it’s even worse: Employee morale has been destroyed, sales are shrinking, and Big Blue seems to have lost its footing in a changing marketplace. The problems started before Rometty became CEO, but she hasn’t helped, and this management clearly lacks the vision and skill to take the company forward.
Some of these problems are internal and specific to IBM, but Goldy has accurately described a business landscape in which big companies have been spending their cash hoards on stock buybacks and dividends instead of investing in their businesses.
Digressing briefly, the reason IBM paid Global Foundries $1.5 billion to take their chipmaking business of their hands, instead of just dynamiting the plant, is because IBM still needs the chips.
Goldy also is correct that cutting taxes for corporations and the wealthy won’t stimulate investment or create jobs. Why? Because the economy’s problem is lack of demand, not lack of capital. The world is awash in idle capital. Who’s going to build a factory to make products he can’t sell? If you want to use tax cuts to create jobs, the tax cuts need to go to consumers, not investors.
There’s more to the stock buyback story than has been stated here by either Goldy or in the comments above. Buybacks can be a good deal for shareholders if the company buys back its stock at low prices. But the reality is companies are no better at market timing than anyone else, and studies show that many buybacks ae poorly executed, and much of the money spent on them is wasted and returns nothing to shareholders.
Nonetheless, company execs prefer buybacks to paying dividends for several reasons:
1. First and foremost, a large part of today’s bloated executive compensation depends on meeting earnings targets, and buybacks make it much easier to hit these targets and trigger executive bonuses, so buybacks are immensely rewarding for execs even if they don’t make economic or business sense and return no value to shareholders. A company with no sales or earnings growth can increase its earnings per share (EPS) simply by buying back its stock, and executive bonuses are nearly always tied to EPS instead of overall earnings growth. So, company managers have a strong self-interest in buybacks, and don’t really care whether they’re profitable for shareholders, because from execs’ point of view they don’t have to be.
2. Artificially increasing EPS through buybacks is one of the best ways to hide poor management performance, because it makes it look like earnings are improving when they’re not.
3. If cash runs short and you have to cut the dividend, investors don’t like that and dump your stock. If, instead, you spend the money on buybacks you can suspend the buyback and nobody will notice and it won’t affect your stock price. So, for CEOs and other company execs, halting a buyback is much less painful than cutting the dividend if you run into cash flow problems.
As a shareholder, I ALWAYS prefer dividend raises to buybacks. Dividends are real money, and they’re money in MY pocket, whereas buybacks often are a will-o-wisp. But I don’t get to determine company policies; I’m merely an owner of the company, which means my opinion doesn’t count for squat under the system of corporate governance we have in this country. I guarantee that most other shareholders, including big ones, feel exactly the same way. But one simple statistic will suffice to tell you whose interest company managements are looking out for, theirs or ours: Over the last 5 years the ratio of spending on buybacks vs. dividends has been 2:1, that is, for every $1 going out the door in dividend payments, $2 has been spent on stock buybacks. For the reasons I described above.
Buybacks have been a major factor in the stock market’s huge run-up since bottoming in March 2009. Companies buying their own stock is a major portion of the trading in what has generally been a thinly traded market since then. This has been a major contributor to the demand for shares that has driven up stock prices, and without it, we’d have significantly lower stock prices. But shareholders don’t benefit from this unless they sell their stock, and most investing strategies call for staying invested over the long haul, so there’s little real benefit here to the average shareholder (such as people investing their retirement savings).
The poster @1 is incorrect in stating that buybacks are more favorable to shareholders than dividend payments because capital gains are taxed at a lower rate than dividends. That was true years ago, but for some time now, dividends have received the same favorable tax rates as CG. Recent tweaks to the rate schedule have modified this slightly for high-bracket taxpayers, but for most of us there’s no tax advantage to receiving our investment returns in the form of capital gains instead of dividends. In fact, many small equity investors hold much or all of their equities in tax-sheltered retirement accounts, where everything is taxed as ordinary income upon withdrawal, so there’s no tax consideration at all.
Let me repeat: Given a choice between dividends or buybacks, I’ll take dividends EVERY TIME. No exceptions.
I’ll close on this note: I received notice today that AbbVie shareholders are getting a 16.7% annual dividend increase this year. AbbVie is one of my larger holdings. How long has it been since you got a wage raise like that?
Needless to say, I don’t work for wages anymore. Under our Wall Street-worshipping capitalist system, working for wages is the worst way of getting money there is. The fact that average workers’ wage income is going down, not up, while capitalists like me need rakes to scoop up all the corporate profits being shoveled at us, should tell you the system isn’t working the way it’s supposed to. The incentives are all screwed up. The rewards are even more screwed up. Someone else’s labor earned that money. The system gave it to me. Conservatives argue I’m being paid for taking risk. What risk? My AbbVie stock has done nothing but go up. AbbVie gives me dividend raises that poor working slobs can’t even dream of. What’s wrong with this picture? Damn near everything, and I’m not afraid to say so, even though I benefit from it.
At a minimum, my stock market winnings should be taxed at the same rate as wages, instead of half the rate working stiffs pay. If you want to incentivize unproductive greed and disincentivize productive work, I can’t think of a more effective way to do it.
Please bear with the lengthy comment. It’s a complicated topic, and to do it justice, I covered a lot of ground.
I enjoyed reading it
Thank you Roger Rabbit. You hit the nail on the head. It seems that for large numbers of corporations now corporate strategy can be defined as ‘support the share price, enhance executive remuneration’. The lack of broader ambitions is truly dispiriting.
Here’s a question: If a company buys back ALL of its stock, who owns the company? Can a company own itself? If management then issued a few shares to themselves wouldn’t they own the entire company?
@3
Perhaps, rather than stock buy-backs, companies should keep the cash on their balance sheets. Cash always improves certain liquidity ratios, like Current Ratio, Acid Test Ratio, and cash is the biggesy part of Working Capital. Also, using cash to extinguish liabilities definitely improves leverage rations.
@11 For stock held in an IRA, dividends aren’t taxed until an IRA withdrawal is made, so whether an IRA receives a cash distribution to shareholders in the form of buyback or dividend has no tax effect.
IBM continues to sink today and is now almost $30 lower than I sold my IBM shares for a few weeks ago. I was lucky this time. Earlier this summer, I was lucky with Walgreen too, selling at $74 just before it plunged to $60.
@17 That invites activist shareholders to come in and take over the company, but an even bigger problem for the people who run companies is they don’t cash in that way. In any case, what companies “should” do has nothing to do with it unless you can buy enough stock to appoint your own board. Corporate governance in modern-day America is marked by ordinary shareholders having zero say in how the companies they supposedly own are managed. I don’t even bother to vote my proxies; I just tear them up.
@17
That’s “ratios,” not “rations” at the end.
@20
Roth IRA’s are the best, assuming one qualifies to make contributions to a Roth. Traditional IRAs are OK, but there’s always the chance of co-mingling pre-tax and post-tax contributions. Plus, you have to start emptying Traditional IRAs at age 70 1/2 and keep track of your exclusion ratios for tax reporting.