Hello, New York? Buy IBM
April 9, 2007 Timothy Prickett Morgan
While the end of the calendar year is often when we look back and examine what we have done in the prior 12 months and even further back through the years, spring is actually a time for renewal. It is when the sap starts to run, when the juices get flowing, when the earth warms, and the sun can reach your bones again to warm you. It is perhaps fitting, then, after a warm spell here in New York followed by a cold snap just after Passover and just before Easter that I ponder the future of IBM.
International Business Machines has been a public company for so long that it took a very long time to find out that it was listed on the New York Stock Exchange in 1916. In 1914, the year Thomas Watson, Sr., took over the company, it would have cost $27.50 a share to buy a piece of the C-T-R, as IBM was known back then (it did not change its name to IBM until 1924). C-T-R had $9 million in sales in 1916, unknown profits, 1,346 employees, and 700 stockholders. At the end of 2006, 91 years after Watson hired banker J.P. Morgan to take C-T-R public, IBM posted sales of $91.4 billion; $9.4 billion in profits; 355,766 employees; 613,933 stock holders, and a market capitalization of around $145 billion at the end of 2006. IBM has grown by many orders of magnitude on every measurable dimension. IBM has generated more profits in its long history than perhaps any other company besides Microsoft–and we’ll see how well or poorly Microsoft will do in its next 60 years of existence. Microsoft, being a maker of software with hardly any manufacturing costs, had it easy. IBM had similar profits through much of its history while having to shell out capital to build factories and manufacturing actual products. Bill Gates had it a lot easier than Tom Watson ever did. In oh so many ways. Both were ruthless, too, and vicious competitors who love their companies. Watson never walked away from his. But he was fired from his previous employer, NCR, for dubious business practices. Both are convicted monopolists.
But none of this is the point. Somewhere, back in my brain, I have this recollection that Watson always regretted that day back in 1916. I think I read it in Father, Son & Co, Tom Watson, Jr.’s, memoir of growing up at IBM and eventually running the show; I let someone borrow my copy of it years ago and have never replaced it in my library of IBM History. Assume that it is true. As it turns out, 2007 is the perfect year to fix that mistake.
Going down to Wall Street to take out a loan in the form of stock offerings was necessary to fuel the early growth of the C-T-R, and it was similarly required as IBM floated more shares on the New York Stock Exchange to fund its development of punch card equipment, electronic computers, mainframe and minicomputer systems, and PCs and servers over the decades as tabulating turned to data processing and then to information technology.
But let’s face some facts. First, it is a grind to make numbers each quarter. Public companies talk about their long-term plans, but they live paycheck to paycheck in 13-week increments. It is a rare chairman of a public company that will sacrifice profits and therefore his company’s stock price to make decisions that are better for the company in the long run. Then, add in the substantial reporting and compliance requirements that large public companies have. Then think about how much you have to say about your business and how much this teaches your competitors about what you are doing.
And finally, there is the stock price issue. IBM’s shares rocketed up from the toilet to after it nearly bankrupted itself in the early 1990s to almost hit $140 a share a few times in the late 1990s and early 2000s. For the past four years, the stock has been in the range of $90 a share, give or take, and it shows no signs of breaking through the magic $100 mark and holding well above it so the shares can split again. IBM’s revenue growth (even after discounting its divestiture from the hard disk and PC businesses it invented in recent years) and profit potential does not warrant a lot of excitement on Wall Street. IBM is a mature company in a maturing business that needs a lot of people to provide the goods and services it delivers. It takes IBM twice as many people to deliver less revenue as Hewlett-Packard.
Being a public company just isn’t what it is cracked up to be, as the wave of private equity takeovers in all manner of industries is demonstrating. Which is why IBM might be better off if some big sugar daddies came along and took Big Blue private.
It would take a lot of money to do that, to be sure. Those 1.5 billion shares that IBM has out there in the pension funds of the world are not going to be cheap–probably something on the order of $120 a pop is my guess, which would be a 25 percent premium over the closing price on Thursday as I write this story.
But here’s the deal, in case you have not been reading the paper. All of the big pension funds in the world, as well as lots of rich folks who don’t have to tell you their names when they invest in funds at private equity firms, have apparently come to the conclusion that the public markets do not offer as good a return as the Old Boy Network. Private equity firms have tremendous access to capital, and in the IT sector, that capital is being used to accelerate consolidation in the industry and to try to gain advantage through scale and scope in particular pieces of the industry. Every time I turn around, another player is either snapped up by a private equity collective or a public company that has access to similar capital resources given its dominant position in one or more markets.
It would probably take a consortium of private equity firms to take IBM private, but there is one that is perhaps uniquely qualified for the job: The Carlyle Group. Carlyle has come out of nowhere to become one of the big players in the private equity game, and is not only stocked with high-level government officials, but also has Louis Gerstner, IBM’s former chairman and chief executive officer, as its chairman. Carlyle is where Gerstner retired to, and since that time, it became the first fund to raise $10 billion and as of the end of 2006, when private equity funds were expected to raise around $400 billion in total to do acquisitions, Carlyle had nearly $45 billion in assets under management.
So why would anyone buy IBM? It has a very large annuity-like revenue stream from its mainframe business, which throws off an incredible amount of services. Private equity firms like cash, and IBM generates plenty of it. Moreover, the sum of IBM’s parts is worth less than the pieces. This was true when Gerstner took over in April 1993, and it is true today. The difference is, IBM was nearly bankrupt when Gerstner came in and reorganized it, and despite the correct impression that IBM’s various units could have done better as separate companies than they did as part of Big Blue, there is no way Gerstner could have broken up IBM in the early 1990s. The company was, to put it bluntly, too screwed up.
But, here we are in 2007, and pension funds and rich people are willing to provide the financial cover and a length of time–perhaps a few years–for a substantial reworking of the IBM Company. And that might just give its various platforms a better chance to live. For instance, I can imagine the System i division being spun out entirely and becoming a customer of a Power chip company and a middleware company. i5/OS and DB2/400 have very little in common with other IBM software. Mainframes would be a separate business, and so would various services companies. IBM’s software business could be cut free of the hardware business to a large degree and then that software company would be able to do what IBM should have done a long time ago: Buy SAP and get back into the software business it should never have abandoned in the first place.
Baby Blues. It is an interesting thought experiment–again, after a fifteen year hiatus. And one Watson would never agree to, by the way. But, then again, he would have never let printers, disks, and PCs go, either.