Saturday, December 31, 2011

Canadian Business & IBM

Well it appears I was quoted over at another major news publication, Canadian Business.  To read the article click below.

I must apologize... I have been very busy with work lately and haven't been able to post.  In short I am transitioning into a new role back at the parent company from a subsidiary.  I have really enjoyed my time at the subsidiary as it was much smaller (than the parent) and working through the unique business challenges we faced has definitely helped me become a better investor. 

One key point I have learned is how sticky business and business relations are.  Things don't change drastically over time.  In fact many companies resist change because of fear of the unknown.  For example, if you changed suppliers how can you trust the new products, quality, or service?  From this perspective you can see how Warren Buffett likes the stickiness of IBM.  IBM's competitive advantage is the relationships they have built with hundreds of businesses around the world. 

Speaking of IBM, shortly after Buffett announced his purchase of IBM stock he also mentioned one other detail.  It was that he read the book, Who Says Elephants Can't Dance? Inside IBMs Historic Turnaround by Louis V. Gerstner Jr., not once but twice before buying the stock.  That was I needed to hear so I quickly got my hands on the book. 

The book is an account of some of the steps Mr. Gerstner took to save IBM.  Back in 1992 IBM was on the brink of failure, bleeding cash, and left for dead by wall street.  Kind of sounds like Blackberry, except Blackberry isn't even close to losing money yet.  Basically, IBM became a victim of their own success and seemed unwilling to adapt to the changing computing world. 

The most interesting fact in the book is Mr. Gerstner's background. It is definitely not what you'd expect for a CEO of a computing giant.  He had worked for McKinsey & Company (consulting), American Express, and finally was the CEO of RJR Nabisco before coming to IBM.  Although he was educated in engineering he went straight into Harvard for an MBA and had zero experience in computers, software or IT. 

Despite his unusual background Mr. Gerstner did turned transform IBM into one of the most successful IT companies in the world prior to his retirement in 2002.  He transformed not only their competitive position but radically transformed the culture to become customer centric and customer focused.  These and many other good leadership principles are discussed in the book. 
Anyway, I have been working on a few new posts and how to be back soon with some good new content and discuss some stocks for the year ahead. 

Happy New Year!

Disclosure - I own shares in BRK.b, thus I indirectly own shares in IBM.


  1. When Buffett buys, I'm always wanting to follow. IBM is a cash generating machine. I can't see anything negative about this company or any ratios that aren't phenomenal.. ROE, ROIC, P/FCF. The only potential cause for concern is its high debt/equity of 1.1. It has more than enough cash to cover its interest and pay down the principal. I am curious how it has accumulated so much debt when it pumps out cash.

    Very close to a buy for me..

  2. Hi Tom,

    Good questions. IBM is a cash cow. 100% of their earnings are distributable to shareholders. In 2011 they will generate around $15.6 billion in profits, pay $3.45 billion in dividends, and buy back $14 billion in stock. Since dividends and share buybacks are higher than earnings the debt will increase.

    I really wouldn’t worry about IBM’s debt load at 50% of capital. Yearly earnings cover yearly interest by 44 times, and debt due in 5 years is $18 billion. Since yearly earnings are roughly the same as debt due over the next 5 years it’s really nothing to worry about.

    Given IBM’s reoccurring service revenue streams, their earnings and cash flow are very stable. As I said they are very entrenched with their customers.

    IBM is a good investment but don’t expect outsized returns. At the current price you will only earn between 7-10% going forward. They should double every 7 years. Downside risk is very low. If you could buy IBM for $125/shr your returns would look very different.

    What is remarkable is that Buffett paid 8.4 times book value. At the beginning of his career he would have never made an investment like this. He must believe that the 30% returns that IBM generates on capital can be sustained long into the future.


  3. Tom,

    I guess I didn't really answer your question.

    The reason any company uses debt is to amplify the returns to the equity holders.

    Since IBM earns 30% on capital and pays less than 5% interest on their debt, the incremental 25% return on the debt goes to the shareholders. It's leverage, you can do more and own more productive assets for the equity shareholders.

    So in IBM's case, the use of leverage earns the shareholders an additional $6.2 billion in profits annually compared to what they could earn if they didn't employ any debt.

    So for IBM to borrow money to buy back shares is a fantastic money making proposition.

    Just don't forget that debt is a doubled edged sword. It can not only amplify returns, but amplify losses.

    Best Regards,

  4. Good posts. Buffett must strongly favour the massive and consistent ROE and last year's double digit growth in 40 countries. If I can get IBM close to what the best investor of all time made a massive stake (16% of his equity portfolio!), I will do so.