International Business Machines:

IBM
Presented by: Zahra Bajgiran, Mikhail Karasik, Jason Oakley,
Kyle Thoresen, and Svetlana Zotikova

Company Overview

Founded in 1911 through the merger of 3 companies

Old success: predominantly hardware-based up to 1990s
New success: 84% of business is software and services
410,830 Employees

Weight of
Debt, Equity

1 - Market value
2 - Book value

Book

Market

Total long term

debt

21,932,000

21,932,000

Total
shareholder
equity

22,637,000

173,724,904

Total Capital

44,569,000

195,956,904

Weight of Debt

49%

11%

Weight of equity

51%

89%

Weight of Debt, Equity

Market

Book

Weight of Debt
Weight of Equity

Weight of Debt
Weight of Equity

Cost of Equity
CAPM model
Ks = Krf+(RPm)*b

Beta
0.819

R2
0.35

Result
7.94%

Bond-Yield-plus-Market Risk Premium

Kce=Kd+RP

Bond Yield
4.65

MRP
5

Result
9.65%

Fama-French Model
ks = kRF + bi(rM - rRF) + ci(rSMB) + di(rHML)

Result
8.76%

Cost of Debt
(1) Total interest expense paid/total debt based on balance sheet

Total debt:
Interest expense paid:
Kd:

0.0154023

26,100,000
402,000
1.54%

(2) Annual report:

Total debt:
Interest expense paid:

Kd:

4.25%

26,100,000
1,109,000

WACC
WACC = Wd*Kd (1-T)+We*Ke

Tax rate: 25.9%

Wd: 11%
Kd: 4.65% (Bond Yield)
We: 89%
Ke: 7.94% (CAPM), 9.65% (BY+RPM), or 8.76% (FF)

WACC
Model

WACC

CAPM

7.43%

Fama-French

8.16%

Bond YieldPlus
Market Risk Premium

8.96%

Sales Growth Rate

2004: 2.43% Growth

2005: 2.37% Growth
2006: 2.32% Growth
2007: 2.27 % Growth
2008: 2.22% Growth
Forecasted Sales
2009: 2.17% Growth
2010: 2.12% Growth
2011: 2.08% Growth
2012: $109,649,000

COGS and R&D Ratios

1st Qtr 2010
Total Revenue

2009

2008

2007

2006

2005

$22,857,000 $95,758,000 $103,630,000 $98,786,000 $91,424,000 $91,134,000

R&D

$1,509,000

$5,820,000

$6,337,000

$6,153,000

$6,107,000

$5,842,000

COGS

$12,880,000 $51,973,000

$57,969,000

$57,057,000 $53,129,000 $54,602,000

Percent of Total Revenue

Average

R&D

6.60%

6.08%

6.12%

6.23%

6.68%

6.41%

6.35%

COGS

56.35%

54.28%

55.94%

57.76%

58.11%

59.91%

57.06%

Forecasting: AFNs
Additional Funds Needed
Short / Current Long Term Debt
Long Term Debt
Additional Interest

2010 Pass
(12,442,178)
(1,986,935)
(10,455,243)
(191,638)

(141,843)
(22,651)
(119,191)
(2,185)

(1,617)
(258)
(1,359)
(25)

(18)
(3)
(15)
(0)

Additional Funds Needed

Short / Current Long Term Debt
Long Term Debt
Additional Interest

2011 Pass
(12,883,277)
(2,057,375)
(10,825,902)
(198,432)

(146,871)
(23,454)
(123,417)
(2,262)

(1,674)
(267)
(1,407)
(26)

(19)
(3)
(16)
(0)

2012 Pass
(13,329,446)
(77,058)
(405,481)
12,846,906
(7,432)

(5,501)
(0)
(0)
5,501
(0)

(0)
N/A
N/A
(0)
N/A

N/A
N/A
N/A
N/A
N/A

Additional Funds Needed

Short / Current Long Term Debt
Long Term Debt
Additional Short Term Investment
Additional Interest

Free Cash Flow Growth

FCF = NOPAT- Investment in Operating Capital
2012

2011

2010

2009

2008

13,334,928

13,037,325

12,739,721

16,483,544

21,872,607

13400000

2010 12,739,319

13300000

2011 13,036,797

2.34%

2012 13,334,272

2.28%

13000000

2013 13,631,753

2.23%

12900000

2014 13,929,231

2.18%

12800000

2015 14,226,709

2.14%

2016 14,524,187

2.09%

13200000
13100000

12700000
2009.5

2010

2010.5

2011

2011.5

2012

2012.5

Intrinsic Value of Operation

Horizon value = FCF2012*(1+g)
WACC- g

Operation Value = PV of expected FCF

WACC

8.56%

Average growth rate

2.23%

Horizon value

215,384,326

Adjusted FCF

228,719,254

Intrinsic Value of Operation

$201,565,552

13,037,325

12,739,721

Corporate Value & MVA

Total Value = Vop + Vnon-operating assets
Operating value

201,565,552

Non-operating Value

1,791,000

Total Corporation Value

$203,356,552

MVA = Market Value of Stock - Total Equity

Intrinsic Value of Stock

$133.56

Actual Stock Price 2009

$130.90

Intrinsic MVA

$154,619,552

Intrinsic Equity Value &

Stock Price
1. Total corporation value
2. Less: Value of debt
Preferred stock
3. Intrinsic value of equity
4. Divide by number of shares
5. Intrinsic value per share
Actual stock price on 12/31/09

$203,356,552
$26,100,000
$0
$177,256,552
1,327,157
$133.56
$130.90

MMM Approach

Computer Software/Services = 84%

EBIT multiple = 11.35

Computers/Peripherals = 16%

EBIT multiple = 10.28

EBIT Multiple for IBM

= 11.18 (Weighted average)

Intrinsic Value of Stock Per Share

= $136.50

Actual stock price on 12/31/09

= $130.90

ROIC and EVA Analysis

ROIC = NOPAT / Operating Capital = 18.20%
WACC = 8.56%
ROIC - WACC = 9.64%

(Firm is adding value)

EVA = Operating Capital * (ROIC-WACC) = 7,268,268

IBM Firm Value

WACC influences firm value
Intrinsic value of stock ~ (1 / WACC ) n
Industry has higher cost of debt, but similar cost of equity
Industry Name

Beta

Computer Software/Services 1.02

Cost of Equity

WACC

Cost of Debt

Weight of
equity

Weight of
Tax Rate
Debt

After-tax Cost of
Debt

8.94%

8.84%

7.84%

94.68%

5.32%

10.12%

7.05%

Computers/Peripherals
Industry (Weighted
Average)*

1.29

10.28%

9.97%

7.84%

90.14%

9.86%

8.65%

7.16%

1.06

9.15%

9.02%

7.84%

93.96%

6.04%

9.88%

7.07%

CAPM

0.82

7.94%

7.43%

4.65%

88.79%

11.21%

25.98%

3.44%

Fama French

N/A

8.76%

8.16%

4.65%

88.79%

11.21%

25.98%

3.44%

Bond Yield + Risk Premium

N/A

9.65%

8.96%

4.65%

88.79%

11.21%

25.98%

3.44%

Average (FF) and (BY + RP)

N/A

9.21%

8.56%

4.65%

88.79%

11.21%

25.98%

3.44%

IBM Firm Value

Dependent on method used to determine cost of equity
Some methods were remarkably close
Average of FF and Bond Yield + Risk Premium showed best correlation
Bond Yield + Average (FF) and
Industry
Risk Premium
(BY + RP)

CAPM

FF

MMM

Intrinsic Value of Stock

($/sh)

166.50

143.69

124.62

133.56

123.31

136.50

Actual Stock Price

End of Year 2009 ($/sh)

130.90

130.90

130.90

130.90

130.90

130.9

Was the Stock Overvalued or

Undervalued?

under

under

over

under

over

under

Scenario Analysis
Scenario Analysis (WACC = average of FF and BY + RP)
Average growth rate of FCF (g)
Intrinsic Value of Equity

-1.00%

2.10%

2.37%

3.00%

116,841,271

173,724,986

181,157,046

201,982,962

Total Numbers of Common Stocks Out. 1,327,157,410

88.04
Intrinsic Value of Stock Per Share

1,327,157,410 1,327,157,410 1,327,157,410

130.90

136.50

152.19

Actual Stock Price at the End of Y2009

130.90

130.90

130.90

130.90

Was the Stock Overvalued or

Undervalued?

Stock
overvalued

Fair

Stock
undervalued

Stock
undervalued

MMM

FCF growth positive but less than inflation

IBM is too big to have a large growth rate
Stock probably fairly priced

How to Increase Equity

Reduce WACC (difficult)
Incentivize management to grow FCF
Limit dividend growth (eventually)
In the end, company strategy plays a crucial role

Strategy Shift
15,000

Software/Services emphasis

~$31 / share (1985)

Net Income ($ millions)

10,000

5,000

~$130 / share (today)

0
1950

1960

1970

1980

1990

2000

2010

Year
-5,000

Hardware emphasis
-10,000

~$10.50 / share (1993)

2020

Thank you!