FINANCIAL MANAGEMENT ITERM PROJECT

Course Instructor

Abhimanyu Singh 01Amal Mohan 04Astha Chaturvedi 13Deeptodip Sen 19Sudhanshu Kumar 43

Submitted by

Dr. Kanwal Misra

1. Introduction:

This study aims to find the impact of repurchase of stocks by a company. We have chosen IBM

as an example of it. In May, IBM repurchased $12.5 billion of its common stock from three

banks through accelerated share repurchase agreements which concluded at the end of

February 2008.

1.A. Methodology:

We are following a structured way to analyse the impact of repurchase beginning with the

reasons to repurchase. The steps followed have been listed below:

1) Selection of live example of a company which has done this exercise in the past.

2) Highlighting the need for repurchase by this company

3) Major reasons of repurchase

4) The financial condition of the company before the repurchase

5) The financial condition of the company after the repurchase

6) Market implications

7) Conclusion

1.B. Reasons for repurchase

1) When a company feels that the exchange has discounted the price of its share by a

larger than expected value, the company goes for a repurchase.

2) Improved financial ratios namely ROA, ROE, EPS and P/E ratio. However it’s the by

product of the first motive.

3) To avoid dilution

4) They are subjected to lower capital gains tax rate.

5) To integrate all sister companies less than one umbrella—as is the reported case of

iGATE.

After the initial study of the balance sheet of the IBM for the past three years it can be

observed that the companies Treasury stock has grown year by year.

Year 2008 2007 2006

Treasury Stock (63,945,000) (46,296,000) (38,546,000)

According to Samuel J Parmesan, chairman, president and chief executive officer, IBM, "These

stock repurchases are enabled by IBM’s strong, consistent cash flow and are an important

way of returning value to IBM shareholders.

The IBM repurchase seems to be driven by the reason number one listed above. The financial

ratios show an improving trend superficially. This is in line with the company policy as

communicated by its chairman. The detailed analysis will be the part of this whole exercise.

2. Company profile-IBM at a Glance:

International Business Machines Corporation, abbreviated IBM and nicknamed "Big Blue" (for

its official corporate colour), is a multinational computer technology and consulting

corporation headquartered in Armonk, New York, United States. The company is one of the

few information technology companies with a continuous history dating back to the 19th

century. IBM manufactures and sells computer hardware and software, and offers

infrastructure services, hosting services, and consulting services in areas ranging from

mainframe computers to nanotechnology.

The company which became IBM was founded in 1896 as the Tabulating Machine Company[9]

by Herman Hollerith, in Broome County, New York (Endicott, New York, where it still

maintains very limited operations). It was incorporated as Computing Tabulating Recording

Corporation (CTR) on June 16, 1911, and was listed on the New York Stock Exchange in 1916.

3. Repurchases history of IBM:

Buyback is not new to IBM.It has done this from time to time. There are many instances

where the company has exercised this option. This is one of the philosophies of this

organisation to retain the market value of its shares.

3.A. Buyback of 1998:

When asked why IBM is spending money on stock buybacks, a company spokesperson, John

Bukovinsky, said: "IBM buys back shares in part because it generates so much cash from

operations and has little need to build new plants. Most of our sales growth now comes from

computer services, and that takes less investment than building the machines themselves."He

continued: "We assume a gross profit decline of about one per cent a year, primarily as a

result of the changing mix in the products and services we sel l. As services become the

greater portion of the business, we believe the gross profit decline will be offset by

improvements in the tax rate and the tax structure. As a result we will be able to maintain a

net profit of about seven per cent,"

3.B. The motive of 1998 buyback—Negative buyback:

As per One vocal critic of Gerstner (CEO) and a long time IBM watcher, Bob Djurdjevic,

"They're saying they can't think of a better way to invest in the technology industry. Instead

they are paying off Wall Street in exchange for good opinions of IBM stock." As an example,

let's examine the latest quarterly results from IBM. The first sentence of the company's press

release touted that the earnings per share went from $1.35 in the previous year to $1.56 this

quarter. Only in subsequent sentences did IBM point out that profits raised a paltry $100

million from $1.4 billion to $1.5 billion year over year. Revenues were up only eight per cent.

In the same release, IBM revealed profits for the nine months ended 30 September 1998

were $4 billion, exactly the same as a year earlier. Sales for the nine months were $56.5

billion, an increase of three per cent compared with $54.8 billion

This was meant to profit the employees, particularly its executives, who have the biggest

stock options.IBM's CEO sold 142,000 shares for a gain of about $16.6 million. In total

Gerstner became worth about $95 million.

3.C. Buyback of 2007—the positive buyback

On 29th May 2007 IBM (NYSE: IBM) announced that it repurchased $12.5 billion of its

outstanding common stock through accelerated share repurchase agreements.

Under the agreements, IBM repurchased 118.8 million shares, or 8 percent of the

outstanding shares of common stock as of May 29, for an initial price of $105.18 per share.

The shares were purchased from three banks under accelerated share repurchase

agreements, which provided IBM with immediate delivery of the shares. The banks were

expected to purchase an equivalent number of shares in the open market during the next

nine months. The initial price of the accelerated share repurchases was subject to an

adjustment based on the volume weighted average price of the shares during this period. IBM

did not plan to make any additional stock repurchases during this period.

The repurchases were executed through IBM International Group, a wholly-owned

subsidiary of IBM, with $1 billion in cash and $11.5 billion borrowed through a loan

agreement with a number of financial institutions. Principal and interest on the loan were

paid with cash generated by IBM International Group’s non-U.S. operating subsidiaries.

The repurchases were part of the $15 billion authorization for the company’s stock

repurchase program approved by the IBM board of directors on April 24. After executing the

$12.5 billion repurchases, the company had approximately $1.8 billion remaining from this

authorization.

IBM expected 2007 earnings per share growth of 13 to 14 percent, compared with the

11 percent estimate the company provided during its first quarter earnings report. Thes e

estimates excluded the gain from the previously-announced sale of its printer business. The

current estimate reflects the benefit of two to three points of growth, or approximately 14 to

17 cents of earnings per share, from the accelerated share repurchases.

4. The buyback phenomenon

Stock repurchase is a program in which a company buys back its own shares from the

marketplace, reducing the number of outstanding shares. This is usually an indication that the

company's management thinks the shares are undervalued.

A maximum dollar amount of shares to be repurchased is authorized while repurchasing

by the company’s board of director. Just like any investor, the company will buy shares when

the price is right. A treasury stock is used to hold the repurchased shares.

5. General Reasons for repurchase

Firstly, buying back of some of the shares increases the company's earnings per share. Since,

there will be a smaller number of shares over which the earnings will be distributed; the

earnings per share will increase.

Secondly, a stock-repurchase is an indication of excess cash available with the company. Using

this excess cash when a company repurchases its own stock because may be the company

may feel that the current price of the share is less then what it should be. This sends a signal

to investors that the company thinks its own stock is the best investment it could make.

When the company buys back its own stock, it might be because the company wants

to invest in other securities or capital investments. So, the third reason for a stock-repurchase

program can be to acquire shares for management and employee incentive plans, including

stock options and stock-purchase plans, or other qualified retirement plan.

Lastly, company may have a plan to expand its business through mergers and

acquisitions. So, the stock-repurchase plans aim to build currency for acquisitions. A company

would increase its amount of treasury stock so that it could use those shares to acquire

another company. For this reason, a stock-repurchase program could be considered a sign of

growth.

6. Need for Repurchase--IBM buyback

Generally, company stock-repurchase plans are good news for investors. Stock repurchases

can be a sign that a company is financially healthy. Thus a buyback program also often results

in an increase in the price of the stock. This study aims to find the impact of repurchase of

stocks by a company. IBM has been chosen as an example of it. In May, IBM repurchased

$12.5 billion of its common stock from three banks through accelerated share repurchase

agreements that concluded at the end of February 2008.

As stated by IBM, it has always believed in giving good returns to its investors. To do so, the

company keeps on repurchasing its shares so that it can give good dividends. Also, the market

price of the shares increases by such practice.

7. Pre purchase and post purchase analysis

7.A. Ratio Analysis

As we know the stock repurchase of IBM was completed between 2007 and 2008. The ratios

of the two years indicate the implications. The balance sheet of the company is shown in

Exhibit 1 and the income statement for the corresponding year is shown in Exhibit 2.These

data has been used to calculate various financial ratios which has been shown in Exhibit 3.

Exhibit 1-Balance sheet of IBM

Period Ending FY2008 FY2007 FY2006 FY2005 FY2004

Assets

Cash and Short Term

Investments

12.91 B 16.15 B 10.66 B 13.69 B 10.57 B

Net Receivables 28.79 B 26.85 B 24.43 B 28.14 B 28.92 B

Total Inventories 2.66 B 2.81 B 2.84 B 3.32 B 2.94 B

Progress Payments &

Others

0 0 0 0 0

Prepaid Expenses 2.61 B 2.38 B — — —

Other Current Assets 36.10 B 5.58 B 4.35 B 4.71 B 5.12 B

Current Assets Total 49.00 B 53.18 B 44.66 B 45.66 B 47.14 B

Long Term Rec eivables 11.60 B 10.07 B 9.63 B 10.95 B 11.10 B

Investment in Unconsolidated Subsidiaries

271.00 M 416.00 M 456.00 M 550.00 M 560.00 M

Other Investments 1.67 B 1.43 B 918.00 M 566.00 M 1.13 B

Property, Plant & Equipment Net

14.30 B 15.08 B 14.44 B 13.76 B 15.18 B

Property, Plant & Equipment Gross

38.58 B 36.52 B 34.26 B 36.38 B 37.12 B

Accumulated Depreciation 23.50 B 22.08 B 20.50 B 21.21 B 22.43 B

Other Assets 46.22 B 37.12 B 28.34 B 33.50 B 31.95 B

Deferred Charges 19.11 B 11.86 B 21.43 B 20.97 B 18.81 B

Tangible Other Assets 1.61 B 1.42 B 964.00 M 756.00 M 569.00 M

Intangible Other Assets 16.39 B 15.06 B 11.10 B 10.23 B 8.64 B

Total Assets 109.52 B 118.92 B 99.35 B 103.92 B 106.33 B

Liabilities

Short Term Debt & Current Portion of Long Term Debt

12.24 B 8.90 B 7.22 B 8.10 B 6.65 B

Accrued Payroll 4.64 B 4.60 B 3.32 B 3.80 B 3.67 B

Income Taxes Payable 3.67 B 4.67 B 4.71 B 4.73 B 5.48 B

Dividends Payable — — — — —

Other Current Liabilities 15.70 B 13.96 B 12.55 B 13.71 B 13.37 B

Current Liabilities Total 31.20 B 44.31 B 40.09 B 35.15 B 39.79 B

Long Term Debt 23.04 B 13.78 B 15.42 B 14.83 B 16.99 B

Provision for Risks & Charges

13.58 B 13.55 B 13.78 B 15.88 B 14.83 B

Deferred Taxes -449.00 M -3.22 B -216.00 M -2.90 B -2.45 B

Deferred Income 3.06 B 2.50 B 2.44 B 2.22 B 1.84 B

Deferred Tax Liability in

Untaxed Reserves

— — — — —

Other Liabilities 64.86 B 6.91 B 4.14 B 4.24 B 4.83 B

Total Liabilities 96.06 B 90.45 B 70.85 B 70.82 B 74.64 B

Shareholders Equity

Non-Equity Reserves 0 0 0 0 0

Minority Interest 0 0 0 0 0

Preferred Stock 0 0 0 0 0

Common Equity 13.46 B 28.47 B 28.51 B 33.10 B 31.69 B

Common Stock 412.00 M 402.00 M 396.00 M 393.00 M 387.00 M

Capital Surplus 34.78 B 30.87 B 28.53 B 26.28 B 15.88 B

Revaluation Reserves 0 0 0 0 0

Other Appropriated Reserves

-7.17 B -11.85 B -4.23 B -4.52 B -3.45 B

Unappropriated (Free)

Reserves

— — — — —

Retained Earnings 60.64 B 52.43 B 44.73 B 38.15 B 37.52 B

Equity in Untaxed Reserves

— — — — —

ESOP Guarantees 0 0 0 0 0

Unrealized Foreign Exchange Gain (Loss)

3.43 B 2.82 B 2.15 B 2.41 B 1.55 B

Unrealized Gain (Loss) on Marketable Securities

325.00 M 119.00 M 67.00 M 50.00 M 5.00 M

Treasury Stock 63.94 B 46.30 B 38.55 B 31.07 B 24.03 B

Total Liabilities & Shareholder’s Equity

109.52 B 118.92 B 99.35 B 103.92 B 106.33 B

Common Shares Outstanding

1.39 B 1.51 B 1.57 B 1.65 B 1.69 B

Exhibit 2-Income statement for IBM

Period Ending FY2008 FY2007 FY2006 FY2005 FY2004

Net Sales/Revenues 103.63 B 98.79 B 91.42 B 91.13 B 96.29 B

Cost of Goods Sold (Excluding Depreciation)

57.97 B 52.26 B 48.57 B 49.88 B 56.34 B

Depreciation, Depletion and Amortization

5.20 B 4.98 B 5.19 B 4.92 B 4.70 B

Gross Income 45.66 B 41.33 B 37.87 B 36.07 B 35.03 B

Selling, General & Admin

Expenses

27.50 B 25.66 B 24.93 B 24.70 B 22.04 B

Other Operating Expense 0 0 0 0 0

Operating Expenses - Total 5.90 B 5.37 B 5.23 B 6.54 B 6.88 B

Operating Income 15.94 B 13.83 B 12.21 B 11.14 B 10.33 B

Extraordinary Credit - Pretax 0 0 775.00 M

0 0

Extraordinary Charge - Pretax 700.00 M

289.00 M

2.52 B 717.00 M

513.00 M

Non-operating Interest Income 565.00

M

536.00

M

307.00

M

180.00

M

152.00

M

Reserves Inc (Dec) 0 0 0 — —

Pretax Equity in Earnings — — — — —

Other Income/Expenses - Net 1.45 B 1.40 B 1.14 B 2.22 B 1.01 B

Earnings Before Interest & Taxes (EBIT)

17.39 B 15.10 B 13.60 B 11.92 B 10.81 B

Interest Expenses On Debt 673.00 M

620.00 M

289.00 M

236.00 M

143.00 M

Interest Capitalized 9.00 M 11.00 M 16.00 M 4.00 M 15.00 M

Pretax Income 16.72 B 14.49 B 13.32 B 11.70 B 10.67 B

Income Taxes 4.38 B 4.07 B 3.90 B 3.71 B 3.17 B

Current Domestic Income Tax 1.23 B 613.00 M

86.00 M -645.00 M

280.00 M

Current Foreign Income Tax 2.10 B 1.56 B 1.44 B 2.02 B 1.86 B

Deferred Domestic Income Tax 664.00

M

1.52 B 1.99 B 1.75 B 522.00

M

Deferred Foreign Income Tax 76.00 M 200.00 M

191.00 M

47.00 M 604.00 M

Income Tax Credits — — — — —

Minority Interest 0 0 0 0 0

Equity in Earnings — — — — —

After Tax Income Expense 0 0 0 0 0

Discontinued Operations 0 0 -24.00 M

-18.00 M

—

Net Income Before Extra Items/Preferred Div

12.33 B 10.42 B 9.42 B 7.97 B 7.48 B

Extra Items & Gain (Loss) Sale of Assets

0 76.00 M -36.00 M

0.00 -30.00 M

Net Income Before Preferred

Dividends

12.33 B 10.42 B 9.49 B 7.93 B 7.48 B

Preferred Dividend Requirements 0 0 0 0 0

Net Income Available to Common 12.33 B 10.42 B 9.42 B 7.93 B 7.48 B

The first thing that is evident from the table is that the shareholders’ equity has reduced in

2008. This is the first direct result of the stock repurchased. From the data we also see that

the ROA has increased to 11.26% from 8.65%. This is mainly on account of the decrease in

cash with the company, as the cash has been spent to buy back the stock from the investors.

Further, the EPS has increased from 7.18 to 8.93, and Price Earnings ratio has decreased from

15.06 to 9.42. Both of these are desirable and could be some of the goals of IBM while

considering the repurchase. However the decrease in P/E ratio is partly accounted for by the

2008 financial crisis, which brought down the market price of the shares.

Exhibit 3

Particulars 2008 2007 2006 2005

Net Income 12,334,000 10,418,000 9,492,000 7,934,000

Shareholders’ equity 13,465,000 28,470,000 28,506,000 33,098,000

Total Assets 109,524,000 120,431,000 103,233,000 105,748,000

Market value per share 84.16 108.1 97.15 82.2

EPS 8.93 7.18 6.06 4.91

P/E 9.42 15.06 16.03 16.74

ROE 12.29% 23.64% 27.61% 31.30%

ROA 11.26% 8.65% 9.19% 7.50%

Treasury Stock 63.94 B 46.30 B 38.55 B 31.07 B

Note: All figures in thousands

7.B. Trend Analysis:

Dividend is a distribution of value to shareholders.

It is believed that during a repurchase plan the company has to offer a price higher than the

current stock price to offer incentives to the investors. It can be seen from the graph below

that that in the year 2008 when the stocks have been repurchased the dividends has shot up.

See exhibit 4.

Exhibit 4

8. Implications:

By offering a price higher than the market's, the company is distributing value to its existing

shareholders. The main advantage of stock repurchase over dividends is that the latter is a

one-time distribution. An increase in dividend is promised to the shareholders, such that the

company would be paying the dividend on a regular basis in the future.

Period of

buybacks—Stock

prices shooting

up

5 Years dividend history

Payable Amount/Share Ex-Date Record Declaration

03-10-2009 $0.50 02-06-2009 02-10-2009 01/28/2009

12-10-2008 $0.50 11-06-2008 11-10-2008 10/29/2008

09-10-2008 $0.50 08-06-2008 08-08-2008 07/30/2008

06-10-2008 $0.50 05-07-2008 05-09-2008 04/30/2008

03-10-2008 $0.40 02-06-2008 02-08-2008 01/30/2008

12-10-2007 $0.40 11-07-2007 11-09-2007 10/31/2007

09-10-2007 $0.40 08-08-2007 08-10-2007 08-01-2007

06-09-2007 $0.40 05-08-2007 05-10-2007 04/25/2007

03-10-2007 $0.30 02-07-2007 02-09-2007 01/31/2007

12-09-2006 $0.30 11-08-2006 11-10-2006 11-01-2006

09-09-2006 $0.30 08-08-2006 08-10-2006 07/26/2006

06-10-2006 $0.30 05-08-2006 05-10-2006 04/26/2006

03-10-2006 $0.20 02-08-2006 02-10-2006 02-01-2006

12-10-2005 $0.20 11-08-2005 11-10-2005 10/26/2005

09-10-2005 $0.20 08-08-2005 08-10-2005 07/27/2005

06-10-2005 $0.20 05-06-2005 05-10-2005 04/26/2005

03-10-2005 $0.18 02-08-2005 02-10-2005 01/26/2005

12-10-2004 $0.18 11-08-2004 11-10-2004 10/27/2004

09-10-2004 $0.18 08-06-2004 08-10-2004 07/27/2004

06-10-2004 $0.18 05-06-2004 05-10-2004 04/27/2004

There are two important implications of "expected regular dividend" and "one-time

distribution." One is that if a regular dividend is lowered, then investors interpret this act as a

bad sign, and thus the price of the stock tends to fall. Because of this built-in expectation,

dividend is a burden on the company, as the company feels obligated to satisfy its

shareholders' expectation. On the other hand, stock repurchase is a one-time deal, and thus,

shareholders don't expect it to continue in any regular fashion in the future.

9. Conclusion:

There is a sign of improvement of ratios which helps build investors confidence. The company

has been able to keep its growth rate in double digits (12% in economic downturn of

2008).Even though the company has a history of negative buybacks also; buybacks has

worked well for the company and the stockholders as a whole.

10. References:

[1] www.EFYtimes.com

[2] www.VCCircle.com

[3] www.PRdomain.com

[4] www.investopedia.com

[5] www.wikipedia.com

[6] www.finance.aol.com

[7] www.yahoofinancials.com