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Analysis of IBM Credit Corp.’s First Half 2000 Business Results

Sharp Drop in New Sales

Operating Leases, State & Local Govt. Financing - Lead the Decline

PHOENIX, Sept. 8   When IBM announced its second quarter business results on July 19, the stockmarket reacted with applause and cheers even though the Big Blue report card was lackluster at best (see “Smoke and Mirrors Galore”). 

The reason?  Wall Street expected bad news and got “only” a lackluster one instead.  So it gullibly fell for yet another rabbit that Armonk pulled out of its hat, using financial engineering and smoke and mirrors to mask its poor business results.

The latest IBM Credit Corp.’s (ICC) second quarter results, however, as depicted in its recently released second quarter 10Q report, served to corroborate our suspicions about Armonk’s financial machinations. 

New financing originations (the leasing industry’s lingo for new sales) were down 8% from the second quarter of 1999.  Not a big deal, of course, until you start looking at the line item details of ICC’s report.  Such as that its operating leases’ sales were down 43%; its capital leases’ new originations were down 14%, and its overall lease originations were down 25%.

For the first six months of 2000, the operating leases’ sales were down 49%; its capital leases’ new originations were down 14%, and its overall lease originations were down 28%.

In other words, the new leasing deals - ICC’s original business and the staple of its financing that accounts for about 85% of its revenues, are plummeting.  In double digits!

And no wonder.  Those who preferred to do their own analysis of IBM’s second quarter results, instead of listen to the deafening (and mind-numbing) Wall Street cheers, could have seen that the staple of the ICC parent’s own business - the mainframe, midrange and PC server hardware - were also plummeting in double digits. 

In fact, the IBM PCs were losing money big time, not just market share, as you can see from our IBM second quarter report.

No wonder, therefore, that the U.S. customer financing subsidiary which is supposed to facilitate the end user acquisitions of these IBM products, is also reeling as a result of the customer rejections of the IBM offerings.

Although IBM does not disclose results of its other (non-U.S.) financing subsidiaries, we have a sense that they are suffering even more than ICC from a lack of demand for their offerings.  That’s because the AS/400 midrange product has basically fallen off the cliff - due to “product transitions,” according to IBM.  And since the non-U.S. markets, especially Europe, account for more than two-thirds of the AS/400 sales, we suspect that the Big Blue foreign financing subsidiaries are having an even tougher time than ICC.

But back to ICC, so if the leasing business is going into a tank, are the rest of ICC’s offerings making up for the slack?

Text Box:  Hardly.  The biggest and the most profitable segment of ICC’s new originations, the business that ICC calls “working capital financing,” i.e., the short-term loans helping finance IBM resellers’ inventories, also dropped by 7% in the second quarter.  After declining by 15% in the first.  So for the first six months of 2000, the segment that accounted for 73% of ICC’s new business is also down in double digits - 11%.

And then there are smaller pieces of the ICC pie - the state and local government financing and the installment payment plan purchases by IBM customers.  They are down by 59% and 62% respectively during the first six months of 2000.

Is there anything that ICC does that’s up?

Yes, there is.  It is its software and services financing.  But this segment accounts for only 10% of new contracts, and it is up only in single digits - 6.6%.  That’s hardly going to do it for ICC as a lever to offset the steep declines in its other business activities. 

Besides, even this business segment was down 39% in the first quarter (the “Y2K woes?), but it surged by 52% in the second.

In short, both IBM and ICC were stalling in the second quarter, while Wall Street was applauding.

ICC: IBM’s Cash Cow

Meanwhile, Armonk “financial engineers” have dug deep into ICC to turn the company’s financing subsidiary into a cash cow.  And to help offload some of Armonk’s Selling, General and Administrative (SG&A) expenses onto it.

Thanks to the new accounting rules that went into effect last year (the SFAS 137), which required companies to report revenues and pretax profits by business segments, we now have a new glimpse into the bowels of this IBM subsidiary.  And what the new rules reveal is quite extraordinary.

Text Box:  Far be it from being an orphan that inherited “the Louvre” (IBM’s old Orchard Road headquarters in Armonk), after “Louis XIX” built himself a new “Versailles” (see “Louis XIX of Armonk,” Aug. 1996), ICC has become one of IBM’s new “cash cows.”

In the first quarter of 2000, ICC and IBM “amended their operating agreement,” according to the ICC 2Q00 10Q report, “to allow IBM to charge ICC with an allocation for shared expenses at the corporate and geographic levels.”

The result of this accounting-legal “mumbo-jumbo” was that ICC’s SG&A expenses went up from 16% in the second quarter of 1999, to 20% in the first six months of 2000, while IBM’s supposedly declined in the corresponding period.

Furthermore, ICC’s own accounting magicians pulling white rabbits out of black hats performed a trick of their own.  They turned losses into gains! 

Namely, throwing caution to the wind, they reduced the provision for losses from $15 million in 2Q99, to $8.9 million in the latest period.  Which helped ICC’s bottom line in the first six months of 2000 increase 5% over the corresponding period last year.

Never mind that the first quarter pretax profit for the higher-risk IBM resellers plummeted from 56% in 1999, to 37% in 2000. 

A few bad debts perhaps being written off? And others, yet to come, ignored? Yet ICC reduced its “provision for losses,” an expense item, by 41% in the first six months of the year.

Welcome to the “new IBM:” All smoke and no mirrors.

High Pretax Margins

Except when it comes to ICC pretax margins.  The new accounting rules revealed just how much IBM’s customer financing subsidiary has been a “cash cow” for Armonk. 

In the second quarter of 2000, for example, the pretax margin on the ICC “working capital financing,” i.e., its short-term reseller funding, was - hold you breath - 56%! 

That’s several times higher than IBM’s mainframe pretax margins have EVER been!

ICC’s overall pretax margins weren’t too shabby, either - at 33%.

Again, higher than even the Big Blue margins in the heydays of its monopolistic mainframe era.

See why the Versailles is “borrowing” these days from its Louvre “cash cow?”

Happy bargain hunting!

Bob Djurdjevic

NOTE: The print edition of this report, of course, contains additional charts and tables not included here.

Can you afford not to know such things if you're a global competitor?  To subscribe, just click on , or call us as (602) 824-8111.

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Volume XVI, No. 2000-20
September 8, 2000

Editor: Bob Djurdjevic
Published by Annex Research;
e-mail: annex@djurdjevic.com

P.O. Box 97100,      Phoenix, Arizona 85060-7100
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