Mad Dog 21/21: Borrowed Time

IBM owes a lot of money. At midyear, it told its shareholders that it was carrying $34 billion in long-term debt and another $12.5 billion in short-term debt, for a total of $46.5 billion. That is about 2.7 times IBM’s shareholder equity of $17.4 billion. IBM’s bondholders and banks are confident Big Blue is good for the money, credit rating agencies and Wall Street analysts are generally pleased. But for customers depending on IBM, its financial priorities may be a worry. Bean-counters may tug IBM one way while bit-bashers pull it another.

IBM isn’t alone in its use of large amounts of debt to capitalize its business. Oracle, for example, carries more long-term debt than IBM and Oracle’s revenue is less than half Big Blue’s. But what Oracle does with its finances really isn’t an issue for IBM. Oracle’s borrowing practices make little difference to IBM customers, who usually only want to know one thing about IBM’s wealth or lack of it: Whether Big Blue can afford to invest enough in the future of its key products. Enough for what? Enough to give customers who depend on IBM a strong competitive position, to the extent information technology constitutes part of a user organization’s strategic arsenal.

The Moneylender and his Wife: In 1514, Quentin Massis portrayed a couple with earnings on its mind; they have lost interest in the technology that created the wealth, as signaled by the artist’s hiding of his self-portrait inside a convex reflection.

One of the things that might undermine customer’s confidence is the way IBM borrows money that it uses to buy back its own shares on the open market. For the past few years, perhaps longer, until the beginning of this year, IBM went to the debt markets for several billion dollars each quarter and simultaneously spent about the same amount on stock buybacks. During all that time IBM seemed to be putting a lot of effort into selling off or closing down manufacturing operations, a practice that is expected to continue. Most recently, IBM sold its X86 server group and some related operations to Lenovo. Currently, IBM is on the cusp of the disposition of its semiconductor fabrication facilities.

IBM has taken steps to share its Power chip and server technology with others. Until now, IBM has jealously guarded its proprietary processor technologies, with one significant exception: IBM shared some Power processor designs with Motorola (and Motorola’s corporate successors) in a venture that made the chips used in Macintosh PCs until, nearly a decade ago, Apple migrated to Intel processors. Apple has continued to keep an open mind about the core technologies that shape its products, and notably has used ARM processors in its mobile devices.

IBM’s Debt: Big Blue is a big borrower compared to its own past and the present of other information technology companies.

Power lost out to X86 at Apple because Intel was able to provide improved price/performance plus a rich technological ecosystem. While it is impossible to say how Apple might have fared had it stuck with Power type chips, what actually happened in the wake of Apple’s adoption of Intel engines for its Macintosh line is pretty obvious: Apple is currently the most valuable IT company in the world. Its market capitalization, the total value of its outstanding shares, is in the vicinity of $600 billion. That is more than three times the market cap of IBM, currently around $190 billion.

It turns out that Apple didn’t get to the top by spending vast amounts on R&D or even by outspending all its competitors. Apple reports R&D costs of about 3 percent of revenue. By comparison, IBM’s R&D expenses run about 6 percent of revenue. With Apple bringing in about twice IBMs annual revenue, one doesn’t need an HP-12 see that Apple and IBM spend about the same amount each year on research and development.

So, customers who worry that IBM is scrimping on R&D and thereby condemning users of its proprietary hardware and software to a slow fade to black are probably wasting a lot of nervous energy. Users may wish their key IT vendor made mainframes or IBM i servers or their Power machines its number one product when budgets were worked out, but they are hoping in vain. On the other hand, customers have no basis in bean-counting on which to assert that IBM is starving the development teams on whom they depend. All they can say, if they want to gripe, is that the numbers show that IBM’s number one product is not a server or a storage subsystem or a DBMS; it is earnings per share.

Debt-to-Equity Ratio: IBM’s borrowings are much bigger than the equity of the company’s shareholders.

In 2013 IBM spent between $10 and $15 billion on stock buybacks, boosting the company’s earnings per share; that is twice as much as it spent on R&D. This year IBM’s buybacks may be even higher. But it is singing to a rapt audience on Wall Street. IBM’s shares seem to hold their value even when the market as a whole swoons, because investors count on three things: IBM will fulfill its promises to keep improving earnings per share, IBM will keep paying a dividend and maybe even increase that dividend, and IBM will preserve the morale of its supporters on the buy side.

Critics of IBM might want to argue that IBM’s R&D effort is not run as well as that of other companies. But there seems to be plenty of evidence that IBM is a very successful inventor, evidence that includes the company’s prominence when it comes to earning patents, its steady flow of income from intellectual property it licenses to others, and its noteworthy contributions to the development of open software. However, when it comes to turning its inventions into products that catch the imagination of the marketplace, IBM seems to fall short.

When it comes to wooing the business public or the general public, IBM somehow manages to be part of the scene but never its star. It is always a bridesmaid, never a bride.

Buybacks and Borrowing: IBM has used borrowed money to buy back its shares; this year it has borrowed less and used other assets to pay for the practice.

If there is one company that seems to repeatedly embarrass IBM, more by circumstances than by any effort to harm or even irk Big Blue, that company is Amazon. Amazon has built up a cloud computing business that is the envy of the entire industry, IBM included. But that’s not its only unintentionally mortifying achievement. IBM has vowed again and again to be a leader in mobile computing, chasing users of the iPhone and its ilk and more recently proclaiming undying love for the iPad (while promising to keep flirting with Android tablets, too). IBM and Apple now seem to be best friends, working together on ways to make the iStuff the go-to gear for enterprise mobility and making IBM’s systems and services the server side provider for Apple-packing enterprise employees.

Well, this may all work out nicely. But in the meantime there are a lot of developments in addition to the achievements of Apple and the intentions of IBM. Here’s an example: Kindles. Amazon’s ebook Kindles and more general-purpose Kindle Fire tablets are not the market leaders. The iPad is the most prominent tablet; Samsung’s several products are at the top of the Android heap, and a number of other mobile devices, such as the Nexus products from Google, figure heavily in the mobile computing culture. Still, Kindles bring Amazon direct revenue in the neighborhood of $4 billion a year. IBM’s waning server business will run to something like $15 billion in 2014, about a third from Power iron, a third from mainframes, and the final third the X86 equipment that’s going to Lenovo.

If IBM wasn’t so fully fixated on earnings per share and other interests of the investment community it might well have used some of its $6 billion in annual R&D expenses to create, as Amazon has with Kindle, not merely a product but a thriving market.

But wait, one might say, Amazon has a huge book and media business that inspired the creators of Kindles, and it has a mobile shopping business that is second to none, an activity that provides additional opportunities for Kindle. IBM doesn’t sell books. What does it have in the way of content that might inspire a Kindle-like information appliance? Plenty. IBM software manages a vast amount of enterprise and institutional data. But IBM hasn’t offered an end-to-end solution that it defines since the days of the green screen.

IBM lost the user end during the Wintel PC era. And so far it has missed every opportunity for a revival, particularly the opportunities defined by Apple’s iPhone and iPad, Google’s Android ecosystem, and Amazon’s Kindle. Maybe IBM needs one more example. Right now Microsoft and Oracle need that end-to-end opportunity as much as IBM does. And perhaps one or both of them will come up with successful ideas. But if IBM doesn’t, customers might start thinking about the money they spend on IBM every year. They might begin migrating to a non-IBM cloud system, such as Amazon’s, and putting the money they have tied up in IBM systems into IBM shares, which are as important to IBM today as computers were in the vanishing past.

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