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Oops - IBM
That Old Financial Magic
How do you grow earnings five times faster than revenues? Just watch.
FORTUNE
Monday, February 18, 2002
By Bethany McLean
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The Future of IBM
Eating My Own Words
"Revenues light but earnings comes in fine," wrote Bear Stearns analyst Andy Neff on Jan. 17 when IBM announced its 2001 financial results. Neff's words evoke the biggest criticism of Gerstner's regime: Given that revenues have grown less than 5% annually since 1994, Big Blue's nearly 20%-a-year earnings growth during that time is a product of financial engineering, pure and simple. The gap between revenue growth and earnings growth has become even wider in recent years; in 1999's fourth quarter IBM reported revenues of $24.2 billion and earnings of $1.12 a share. In 2001's fourth quarter, IBM reported sharply lower revenues--$22.8 billion--but sharply higher earnings: $1.33 a share.
Until recently nobody on Wall Street much cared how IBM produced its earnings--a big reason the stock has gone up more than eightfold during Gerstner's tenure. But as accounting practices have come under scrutiny, IBM has taken a hit. Since Jan. 17, the stock has slipped from nearly $120 a share to $108. The key questions: How big an issue are IBM's less than squeaky-clean earnings? And can Palmisano continue to play the game?
IBM's best-known tricks for generating earnings growth--share buybacks and a reliance on earnings that are a result of its overfunded pension plan--are fairly easy to understand. There's nothing inherently wrong with either of those--or with IBM's success at managing down its tax rate, another earnings enhancer. The issue is more the scale of such activity. For instance, from 1995 through 2001, IBM spent around $44 billion buying back shares, a move that enables a company to report higher earnings per share because there are fewer shares. That sum is only a hair less than the company's total net income of $45.5 billion during the same period. Longtime critics like Grant's Interest Rate Observer contend that there must be better uses for the cash than creating the illusion of growth, and that IBM is engaging in a"slow-mo LBO."
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