IBM to Spend $15 Billion In Expanded Stock Buyback

Plan Involves New Debt, But Rating Is Seen Safe; Dividend Gets a Big Lift

By WILLIAM M. BULKELEY

[Chart] International Business Machines Corp. expanded its long-running stock-buyback program, saying it will borrow funds and spend $15 billion to retire shares, potentially reducing shares outstanding by about 10%.

IBM said the action will increase its forecast of growth in earnings per share by between one and three percentage points, resulting in an expected gain of between 12% and 14% for the current year. IBM also boosted its quarterly dividend by 10 cents to 40 cents a share, payable June 9, to holders of shares of record May 10.

IBM shares rose $3.28, or 3.5%, to $98.49 in 4 p.m. composite trading on the New York Stock Exchange.

In an interview, Treasurer Jesse Greene said IBM has been "very underleveraged," considering its size and strong cash flow. He said IBM has about $700 million in "core" debt, excluding borrowing related to its financing business. It had $10.8 billion in cash at the end of the first quarter. He said IBM isn't ready to discuss precisely how much new debt it will take on to fund the buyback. Mr. Greene said IBM's borrowing ability has been enhanced by a reduction in cash-flow volatility from the sale of its personal-computer business in 2005.

Rating agencies Moody's and Standard & Poor's each said that IBM's plan wouldn't cause a downgrade in its debt ratings.

At the annual shareholders meeting, in Knoxville, Tenn., IBM Chairman Samuel J. Palmisano said the decision to shed the PC business has sharply improved IBM's bottom line. He said: "In the seven quarters since ... we acquired 19 software companies, our stock price has gone from 75 [dollars] to where it is today." He also cited gains since the PC-unit sale in gross profit margin, up to 40.2% from 36%, and in IBM's pretax income margin, up to 11.7% from 8.8%.

At the meeting, shareholders approved by 51% a proposal that was opposed by management to require that directors receive a majority of all votes cast, even if votes are withheld from certain directors, which has become an increasingly popular form of shareholder protest. The proposal is nonbinding.

QUESTIONS:

1.) Why will IBM take on additional debt to fund further repurchases of its outstanding common stock? In your answer, describe the impact of the repurchase transactions and the debt on IBM's balance sheet equation.

2.) Define leverage and explain how it affects a firm's profitability. What are the risks that can result from use of leverage to increase profitability?

3.) Why does IBM expect its earnings per share (EPS) to increase following these repurchase and borrowing transactions? Be specific in relating your answer to the calculation of EPS and in relating your answer to the issue of leverage discussed above.

4.) Which components of a firm's cash flow is most important in determining debt capacity ? What is volatility in cash flow? How is that financial measure used to determine the appropriate leverage of a firm?

5.) What is the notion of an optimal capital structure? How do the changes described above possibly lead to that point?