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IBM FINANCIAL

An Analysis of IBM Business Segments, Results per Annual Report 2001

IBM Pension Plan Vapors

Where Did $17 Billion Go?  Plan’s Assets Just above Water, Non-U.S. Under

PHOENIX, Mar. 21 - The anxiously awaited IBM 2001 Annual Report and the 10K, released on Mar. 11, turned out to be much ado about nothing.  At least that’s the impression an average investor would get after having read the business media reports about it.

“No 'Smoking Gun' In IBM's 10K - Merrill Analyst,” read the headline of a Mar. 12 Dow Jones Newswire (DJN).

“In fact the (Merrill Lynch) analyst said Tuesday that IBM's move to include greater financial disclosure in its Securities and Exchange filings "paints IBM's financial position in a somewhat more positive light," the DJN reported.

An ABN AMRO analyst said in a note that there were "few surprises," and the release should be "a positive catalyst for the stock," according to another Mar. 12 DJN story. 

A Prudential Securities Inc. analyst said the "incremental disclosures are a positive step," in the same article.

“Positive,” “positive,” “positive”… Three different comments, the same attribute.

No wonder the IBM shares surged by 3% on Mar. 12, the first trading day after the company’s disclosure.  That’s over $3 billion in just one day that may be directly attributable to sloppy work by Wall Street, if not to self-serving kow-towing to Armonk.

Why? 

Because at the same time as Wall Street was applauding IBM and boosting its shares, we were scratching our heads trying to figure out what happened with $17 billion of the company’s pension fund assets that seem to have vaporized in the last two years. 

Nor was it intuitively obvious to us how IBM could have reported a big INCREASE in “Pension assets” (from $5.6 billion in 1999 to $9.4 billion in 2001 - page 104 of the Annual Report), while showing about a $17 billion DECLINE in “Fair Value of Plan Assets” during the same period (on page 98 of the Annual Report).

And then there was a $1.1 billion discrepancy between the pension asset values reported in two different parts of the Annual Report.

Nevertheless, IBM continued to milk its pension fund to pad its saggingText Box:  operating income.  In this year's report, $1,319 million of IBM’s pretax profit came from its pension fund.  That’s 12% of the total.  In 2000 and 1999, the corresponding figures were $1,171 million and $694 million, or 10% and 6% of the pretax profit respectively (see the chart). 

What was quite clear to us was that the IBM pension fund assets are now just above water ($686 million), having had a hefty $17.2 billion surplus only two years ago.  And that its non-U.S. portion was actually under water now (meaning that its obligations exceeded its assets by $270 million), having enjoyed a $6.1 billion surplus in 1999.

Even more mystifying was a huge swing in the value of something called “Unrecognized net actuarial losses/(gains)” - the next item below the assets-over/under-obligations line.  The way we read it, this account went from a $11.6 billion gain in 1999, to a $7.2 billion loss in 2001.  That’s almost a $19 billion-swing in just two years.

Text Box:

“What’s a billion here, a billion there…”, said one reporter with whom we discussed the matter, perhaps repeating some of our past comments about IBM’s “black magic” accounting.

“Very interesting,” was the reaction of another journalist.  “As usual with pension accounting, I'm getting a headache… I agree, that mysterious jump in unallocated pension assets seems odd.”

IBM did acknowledge a decline in its pension assets but provided no explanation for it except for the usual “trust us” platitudes. 

“…Despite the recent downturns in the equity and financial markets, the trust funds have continued to provide the capacity to meet their obligations to current and future retirees,” IBM said.

Which “recent downturns?” (except for IBM’s).  On the Kabul stock exchange?  For back home, the Dow Jones industrials are up 29% since Sep. 10; and they are up 6% since Dec. 31.

So, rather than keep adding to our own headache about it, we asked the head of IBM investor relations to demystify its pension fund accounting for us.  We also copied the IBM CEO Sam Palmisano on our e-mail letter.

It has now been over a week, and we have still not received a reply.  So we wrote today (Mar. 21) to the chairman of the Securities and Exchange Commission, suggesting that he may want to remind IBM of the fact that they are a public company, and need to answer their shareholders’ and analysts’ questions promptly.  Even the ticklish or prickly questions, such as what happened to $17 billion? 

Meanwhile, when we see the IBM stock going up AFTER it discloses such information, we cannot help but think of Enron, and of the line, “there is a sucker born every day” - on Wall Street, anyway.  Especially after reading IBM’s explanation given to a Wall Street Journal reporter last week:

IBM says the Internal Revenue Service annually reviews corporate pension funds and decrees whether they are underfunded. "Given current market conditions, we see no need to fund the plan for the foreseeable future" (see the “IBM's Overfunded Pension Plan Won't Pump Up the Bottom Line,” a WSJ, Mar. 15 report).

IBM Segment Analysis

Global Services.  IBM Global Services unsurprisingly accounted for the largest share of IBM’s revenues in the last 10 years - $260 billion or 31% of the total.  In the latest full year (2001), however, IBM’s only “crown jewel” of the 1990s accounted for $35 billion or 41% of the total.  Both sets of figures include maintenance revenues.

Led by a surge in outsourcing in the miText Box:  
 

d-1990s, IBM services (excluding maintenance) also led all other segments in terms of its growth rate.  This line grew at a compound annual rate of 23% between 1991 and 2001.  But the services sub-segment rose only by only 13% annually in the last five years.  And it declined in the fourth quarter of 2001, for the first time in history (see “Big Blue Stock to Take a Dive?,” Annex Bulletin 2002-, Jan. 18, 2002).

Maintenance, on the other hand, has been declining steadily at an annual rate of 4% during the 1991-2001 period.

Enterprise Systems.  IBM enterprise systems were the second largest segment in the last 10 years.  Their aggregate revenues of $162 billion represented 20% of IBM’s total during that period.  Unfortunately for IBM, this segment has also been shrinking throughout the period at a rate of 3% compounded annually.

Within that total, the S/390 servers led the decline with a 9% compound annual rate between 1991 and 2001.  The AS/400 revenues shrank at a rate of 5% per year, while the RS/6000 sales grew at 12% annually.  One should keep in mind, however, that the RS/6000 did not exist as a product prior to 1990, so it started the decade from zero.

Software.  The IBM Software unit was the third largest revenue contributor in the 1991-2001 period, with a $152 billion, or 18% of total .  Unfortunately for IBM, this stellar performer from the 1980s, that regularly chalked up growth rates of 20% to 30% per year back then, stalled in terms of its growth in the last 10 years.  The compound annual growth of software revenues was only 2% during the 1991-2001 period.

There were two main reasons for it. First, a decline in the mainframe and other proprietary systems’ fortunes also led to a drop in operating systems software revenues (-5% compounded annually 1996-2001).  The S/390 and the AS/400 OS revenues declined in the second half of the 1990s at compound annual rates of 7% and 13% respectively.  The RS/6000 eked out a meager growth of 4% per year, thanks to a continuing demand for “open systems,” UNIX in this instance.

The so-called “Middleware,” the largest IBM software segment (43% of total in 2001), grew at a compound annual rate of 2% during 1996-2001.  The only sub-segment that showed respectable growth was “Distributed” software (this includes Lotus, for example).  It grew at 18% compounded annually during the same period.

Personal Systems.  IBM Personal Systems was unit the fourth largest IBM revenue contributor in the last decade, chalking up $140 billion in sales or 17% of the total. 

The PC growth, been a meager 1% compounded annually, turned out to be a blessing in disguise for the IBM shareholders.  That’s because this has been a money-losing operation throughout most of its recent existence, sometimes to the tune of $1 billion or more in annual losses.  So had the revenues been bigger, chances are, so would have been the losses. 

What is less understandable, however, is why the top IBM executives have hung on to this money-losing product line, especially since it has not done much for them even in terms of growth.  To keep those factories churning?  Which would par for the course, we suppose, for a company that had been led by a CEO who, upon taking the IBM helm in 1993, declared “the last thing this company needs is a vision statement” (see Annex Bulletins 93-40, 7/27/93 and “Mountain Shook, Mouse Was Born,” 94-12, 3/25/94).

Technology. The $61 billion-IBM Technology segment was born in 1992 to help cover up a $116 billion-blunder that the John Opel-John Akers Armonk administrations made in the early 1980s.  As Akers took over as IBM CEO in 1985, he predicted his company would be a $180 billion company by the end of 1994.  IBM was a “mere” $64 billion corporation in 1994, thus the $116 billion difference.

But Opel and Akers kept spending money on new plants and equipment in line with their $180 billion-vision for the company.  Which meant that IBM entered the 1990s with oodles of extra manufacturing capacity.  The story of layoffs and charges that eventually sank Akers is well known. Perhaps less well know is his effort in the last year of his tenure as IBM chairman and CEO (1992) to ameliorate the situation by entering into the OEM business for the first time in IBM’s history. 

Today’s Technology segment, which produced some $61 billion in revenues in the last 10 years, is what the original IBM OEM business has grown into.  After a fairly quick start in 1992-1995, this unit pretty much coasted in the second half of the decade, before starting to decline sharply in the last two years. 

Summary.  The only IBM real growth segment in the 10 years has been the IBM Global Services operation.  Yet even that unit, despite an outstanding sales record in 2000 and 2001, has dropped down to only a single digit revenue growth rate.  That’s worse than even John Akers’ growth record (see "Gerstner’s Legacy: Good Manager, Poor Entrepreneur", Jan. 2002).

Lou Knighted, Blue (De)lighted

Notwithstanding such lackluster results, the outgoing IBM chairman, Lou Gerstner, was knighted last September by the British crown.  Yes, knighted, not knifed.

For what?  That’s a good question. 

Maybe for skillful tax evasion in Great Britain? (see “Is IBM Cheating on Taxes?”, May 1999, or “IBM Probed for Tax Evasion,” Aug. 1999), or the Wall Street Journal Aug. 6, 1999, or “IBM: Dishonorable Mention,” July 2001). 

Or for shareholder fleecing? (see “Where Armonk Meets Wall Street, Greed Breeds Incest,” Nov. 1998).

Ah… it must be “for education” then - the generic catchall for nominees when the Queen is at a loss to explain why.

Unlike New York Mayor Rudolf Guiliani, who received his honorary knighthood from Queen Elizabeth II at Buckingham Palace ceremony, Sir Louis of Armonk got his feathers at the British Embassy in Washington, DC - four days before Sep. 11 (click here to read the release or on the above image to read about the Gerstner legacy).

Guess that’s better than getting your “Sir” mailed to you.  Since the Embassy press release did not contain any photos of the Lou-peerage presentation ceremony, the above photo cartoon will have to do.  J

Happy bargain hunting!

Bob Djurdjevic






 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Volume XVIII, No. 2002-08
March 21, 2002

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

P.O. Box 97100, Phoenix, Arizona 85060-7100
TEL/FAX: (602) 824-8111

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