Big Blue’s Big Buyback May Spur Stock

05/31/2007 12:00 am EST

Focus:

Jon Markman

Editor, Trader's Advantage

Jon Markman, editor of Jon Markman’s Strategic Advantage, says a huge stock buyback and improved business conditions should put the wind behind the sails of IBM’s stock.

Information age stalwart International Business Machines (IBM) has had a very interesting month—a bit uncharacteristic for a company that, in years past, was better known for its starched-white-shirt-and-tie corporate mentality.

The loosening of the tie was triggered last month when the company’s board—following a largely uneventful first-quarter earnings announcement—decided to restructure the balance sheet, leverage up and throw some serious cash at shareholders. The dividend increased 33%, jumping to 40 cents per share, while a previous share repurchase authorization of $1.4 billion was increased by $15 billion. The move is brilliant, as the company had low levels of debt and lots of cash on hand. But wait, it gets better: IBM is putting the $16.4 billion share buyback on an accelerated track.

Over the past five quarters, IBM has been repurchasing its shares at an average rate of roughly $2.3 billion per quarter. If it maintained this rate, it would take more than seven quarters to drain down the authorization. Erring on the side of instant gratification, IBM hopes to finish its shopping spree over the next four quarters instead. One scenario would see IBM repurchasing some $4 billion dollars' worth of its stock each quarter until the till was empty. (IBM announced Tuesday it had already bought back $12.5 billion worth of stock, mostly using borrowed funds, and it projected higher-than-expected earnings-per-share growth of 13-14% this year—Editor.)

I think IBM’s share price will continue to rise throughout the remainder of the year, even in the face of slowing US economic growth and the concurrent slowdown in technology outlays by corporate America. Offsets include the continued strength in the international arena, as European and Asian economies continue to grow healthily. IBM has also made great headway in slimming down its workforce, as well as reducing pension expenses. Finally, the latter part of the year will bring the launch of a new generation of processors, dubbed POWER6, which will boost demand for IBM’s enterprise-level servers and mainframes.

Combine all these factors, and you’re looking at earnings per share growth of about 16% over the next two years, thanks to the reduced share count. This adds about 20 cents to my 2008 EPS estimate, bringing it to $7.95. Look for the price/earnings multiple to expand slightly, which is fair considering IBM is trading at a 21% discount to its peer group, even after recent gains. With a 16x multiple, we get a 12-month target of $127, which would be [about] a 20% move from here. (IBM closed just below $107 Wednesday—Editor.)

 

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