Unlike other large technology companies that have spent the past few years piling up mountains of cash, International Business Machines (NYSE: IBM) has piled up a mountain of debt. IBM's total debt stood at $45.6 billion at the end of the third quarter, far higher than its cash balance of $11.5 billion. Five years ago, IBM's debt was just $33.7 billion.
IBM's share-buyback program is one reason for this rising debt load. From 2012 through 2016, IBM spent a whopping $47.6 billion on share buybacks. The cash flow covered most of this spending, but not all of it.
Should investors be worried about IBM's balance sheet? In short, no. Here's why.
Image source: IBM.
Two kinds of debt
To get a better sense of the strength of IBM's balance sheet, the debt needs to be broken down into two parts. IBM operates a financing business, called global financing, which provides financing solutions to its customers. Nearly all mainframe systems are financed, according to CFO Martin Schroeter, with an attach rate of about 90%. The latest mainframe launch will boost not only hardware sales but financing volume as well.
Global Financing had a portfolio of receivables worth $26.1 billion at the end of the third quarter, the majority of which are investment grade. IBM borrows money to facilitate this lending. In the third quarter, it issued $3 billion of debt to support the financing business. Global Financing debt now totals $29.4 billion, about two-thirds of IBM's debt load.
The remaining one-third of IBM's debt is corporate debt, not tied to the financing business. This debt was $16.2 billion at the end of the third quarter, less than $5 billion more than the company's cash on hand. Corporate debt has risen over the past five years, but it accounts for only about half of the total increase.
Data source: IBM. Chart by author.
The financing debt certainly shouldn't be ignored. There's always the risk that financing customers default at a higher rate than expected, dragging down the bottom line for IBM. But lumping together the financing debt and the corporate debt and claiming that IBM has too much debt doesn't make much sense. The financing debt is offset by financing receivables; the corporate debt is not.
Plenty of cash and cash flow
About 70% of IBM's $16.2 billion of corporate debt is covered by cash. This debt is also mostly covered by a single year of free cash flow. IBM produced $11.6 billion of free cash flow, excluding financing receivables, in 2016, and it expects to produce roughly the same amount this year.
Interest expenses are not particularly large, either. IBM spent $630 million on interest payments in 2016 on all its debt. The financing portion of that interest is more than offset by financing revenue. The corporate portion is a fraction of the total.
Despite a run-up in corporate debt fueled by share buybacks over the past five years, IBM's balance sheet is still rock solid. IBM has slowed down the pace of share buybacks dramatically in the past couple of years, which has helped to keep the corporate debt in check. The company spent just $3.5 billion on share buybacks last year, down from a peak of $13.9 billion in 2013.
IBM's mountain of debt is nothing to worry about. Most of it supports the financing business and drives sales of mainframe systems and other products. The rest is small enough to be more than covered by cash on hand and a single year of free cash flow. With IBM on the cusp of returning to growth, don't let the balance sheet scare you away from investing in this undervalued tech giant.
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