In the case "H. J. Heinz M&A" what is the financial analysis of the case? Please explain the financials. Send only a word file with the tables of financials and the explanation of each financial.

I attached the case below.

PS. I would like to have the question answered after 18 hours because I have to submit it.

For the exclusive use of A. Osmanai, 2019. 9 - 2 1 5 - 05 8 REV: SEPTEMBER 25, 2017 BENJAMIN C. ESTY E. SCOTT MAYFIELD Generating Higher Value at IBM (A) We are confident in our vision, our strategy, and our prospects. Every generation of IBMers has the opportunityand, I believe, the responsibilityto invent a new IBM. This is our time. IBM CEO Virginia Rometty, March 9, 20141 As she walked out of the IBM investor briefing (the "analyst day") on May 14, 2014, Sophia Johnson, an independent equity analyst at Technology Research Group (TRG), reflected on what she had heard during the day and what she should say to her clients regarding IBM's prospects. At the briefing, IBM's senior leaders, including CEO Virginia Rometty and CFO Martin Schroeter, had reaffirmed the company's plans to transform itself and to achieve earnings per share (EPS) of at least $20.00 in 2015up from $16.28 in 2013.2 Since 2007, IBM had issued long-term EPS forecastsup to five years aheadto help employees and investors understand the firm and its transformation strategy, and had provided quarterly updates on progress toward the firm's long-term EPS targets. Despite 10 years of strong financial performance, IBM reported relatively weak financial results for the first quarter of 2014. Schroeter assured analysts that the challenges were being addressed and that the firm was still on track to meet its 2015 EPS target.3 Given what Johnson had heard that day, she wondered whether this was a time to make a bolder investment recommendation on IBM. Like most of her peers, Johnson had a "hold" recommendation on IBM, which was currently trading at $189 per shareup 90% in the past five years but down 12% off its all-time high of $215 in March 2013. Was this a time to buy on relative weakness and investor uncertainty or a time to get out? Getting this recommendation right was especially important for Johnson who, after being on Institutional Investor's All-America Research team for three out of the past four years, had not made the list last year. IBM: A History of Transformation4 IBM was incorporated in 1911, and was led, almost from the start, by its "founding father," Thomas J. Watson, Sr. Under Watson's leadership, IBM focused on providing large-scale, custombuilt tabulating solutions for businesses with challenging computational problems such as the Social Security Administration, a major client during the 1930s. By the time Watson stepped down as president in 1952, IBM had annual revenues of $412 million, more than 41,000 employees, and offices around the world.5 He was replaced by his son Thomas J. Watson, Jr. who, like his father, had a new vision for computing machines. This time, however, the vision was of computers rather than Professor Benjamin C. Esty and Senior Lecturer E. Scott Mayfield prepared this case. This case was developed from published sources. Funding for the development of this case was provided by Harvard Business School and not by the company. Both Sophia Johnson and the Technology Research Group are fictional. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright 2015, 2016, 2017 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. 215-058 Generating Higher Value at IBM (A) tabulating machines: IBM introduced the first electronic computer during the 1950s. By the end of the 1950s, IBM had revenues of $1.6 billion and 95,000 employees.6 During the 1960s, IBM's management faced the challenge of trying to keep up with, if not lead, the rapid advances in data processing technologies. Watson, Jr. made the strategic decision to stop offering a "one size fits all" mainframe computer and introduced an entirely new "family" of mainframe computers, the IBM System/360, in 1964, which allowed users to migrate to more powerful machines as their needs changed. Dubbed "IBM's $5 billion gamble" by Fortune magazine,7 Watson's decision paid off: within months of introducing the System/360, IBM had received orders for over 2,000 machines. Over the next decade, IBM experienced a fivefold increase in revenues and earnings, and by the end of the 1970s, IBM had revenues of $22.8 billion and 337,000 employees.8 In contrast to the growth and profits during the 1960s and 1970s, IBM entered a period of dramatic change during the 1980s and 1990s. IBM introduced its personal computer, the IBM PC, in 1981 as a low-cost computer for homes, schools, and small businesses. Given its historical emphasis on mainframe computing, IBM was not well positioned for the sweeping changes that the PC revolution brought to the marketplace. As a result, revenue fell from a high of $69 billion in 1990 to $63 billion in 1993. To address the problems, Louis V. Gerstner, Jr. was appointed chairman and CEO in 1993. Gerstner (HBS MBA 1965) had been the CEO of RJR Nabisco and became the first CEO from outside IBM in the company's history. To stabilize the company, Gerstner restructured product lines, reduced head count, and trimmed costs. Gerstner said: I think the greatest challenge facing the company is not to put in place all the fundamentals needed to succeed in this industry but rather to adapt our strategy, structure and culture to a world of constant change. IBM will be marching to a different drummer but we will preserve those things that made this the great company it still is today. I'm not seeking change for change's sake. I'm seeking change for IBM's sake.9 Having addressed the company's immediate problems, Gerstner articulated a new vision for IBM: network computing would drive the next phase of industry growth and would be central to IBM's strategy. Gerstner introduced the term "e-business," and announced a new strategic campaign predicated on the notion that the Internet would challenge traditional business models and transform the nature of transactions. Under his leadership, IBM undertook a series of transformational initiatives that shifted the company's focus toward software and services, including the acquisition of Lotus Development Corporation in 1995 and the eventual acquisition of PricewaterhouseCoopers Consulting (PwC) in 2002. By the end of the decade, IBM had revenues of $83 billion and had reestablished itself as an information technology leader. The company's transformation continued under the leadership of Samuel J. Palmisano, who succeeded Gerstner in March 2002. Palmisano did three important things during his tenure. First, he helped create a new value statement in July 2003: "Dedication to every client's success; Innovation that mattersfor our company and the world; and, Trust and personal responsibility in all relationships."10 Second, he expanded and united the firm's global operations to create a "globally integrated enterprise." And third, he articulated a new vision of technological change and redirected the strategy. Based on this vision, IBM divested its lower-margin personal computing, disk drive, and D-ram chip businesses (the commoditizing businesses), shifted investment into growth markets (services and software), and introduced the "Smarter Planet" initiative, which combined data, research, and intelligent systems to develop actionable insights for large-scale applications such as traffic management and health care. During his tenure, IBM grew revenues from $81 billion to $107 2 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. Generating Higher Value at IBM (A) 215-058 billion and increased its gross margins by almost 10% (see Table A). Given its revenue, each percentage point increase in gross margin equaled approximately $1 billion of incremental gross profit annually. In short, Palmisano dramatically transformed IBM's strategy, product mix, and structure. Table A Changes in IBM's Revenue Mix and Profitability, 2002-2011 Business Segment Global Services Hardware/Systems Software Global Financing Enterprise Inv./Other Total Total ($B) Source: Revenue (% of Total) 2002 2011 44.8% 33.8% 16.1% 4.0% 1.3% 100.0% $81.2 56.7% 17.9% 23.5% 2.0% n/a 100.0% $106.9 Gross Profit Margin (%) 2002 2011 26.3% 27.1% 84.4% 56.5% 42.6% 37.3% 33.0% 39.8% 88.5% 49.8% n/a 46.9% Change 2002-2011 Revenue Margin 11.9% -15.9% 7.4% -2.0% n/a 6.7% 12.7% 4.1% -6.7% n/a 9.6% IBM, 2002 and 2011 annual reports. Commenting on the transformation, Palmisano said, "We saw changes. We adjusted. We focused on cash and profitability, not top line. . . . We became much more confident in our cash generation potential. We returned more to the shareholder. That's it in a nutshell. That's the IBM story."11 In January 2012, Virginia (Ginni) Rometty replaced Palmisano as CEO. Rometty had previously been Senior Vice President of IBM Global Business Services and had led the successful integration of PwC. Rometty described Palmisano this way: "Sam had the courage to transform the company based on his belief that computing technology . . . would shift in historic ways. All of that has come to pass. . . . Sam taught us, above all, that we must never stop reinventing IBM."12 Transformation continued to be an important theme during Rometty's tenure. In the chairman's letter in the firm's 2012 Annual Report, she wrote: IBM is an innovation company. Both in what we do and in how we do it, we pursue continuous transformationalways remixing to higher value in our portfolio and skills. . . . To sustain an innovation model in our industry, a company must do more than accommodate major technology shifts. It must lead them. IBM has done this repeatedly over the past centurynot only pioneering new technology models, but capturing significant economic value. Today, another new wave is sweeping in powered by Big Data, analytics, mobile, social and cloud. . . . So we are, as we have so often done in the past, reshaping our investment, innovation and market strategies to lead.13 Exhibits 1, 2, and 3 provide 10 years of income statement, balance sheet, and cash flow data from 2004 to 2013. During this period, IBM distributed $140 billion of cash to shareholders through both dividends and share repurchases, while its leverage ratio (debt-to-total capitalization ratio) rose from 43% to 63% (Appendix A describes various mechanisms for cash flow distribution). When Gerstner had followed a similar financial strategy in the previous decade, one analyst called it a "slow motion LBO" (leveraged buyout).14 3 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. 215-058 Generating Higher Value at IBM (A) The 2010 EPS Roadmap When Palmisano became CEO in March 2002, IBM's stock price was trading at $100 per share. (Exhibit 4 shows IBM's stock price from January 2002 to May 2014.) Five years later, despite considerable changeacquisitions, divestitures, new leadership, new values, and new strategythe company was still trading near $100 per share. Palmisano said, "the market didn't see all the great things we were doing."15 To address this problem, he described the history of and the motivations for creating a long-term financial goal as part of the firm's transformation strategy: We gave investors annual outlooks, and we gave them [quarterly] earnings. You have to give them somethingthey're the owners. But the criticism at the time was that they couldn't understand us. We were too complicated. You want people to have some clarity so they will invest in you. . . . [But] I felt the orientation around a 90-day outlook was distorting to management practice. Not every quarter is going to be perfect. We all know that operationally, but you're still pressured to do things that aren't necessarily in the long-term interest of the entity in order to make your numbers. . . . We thought that if we could come up with something longer term that gave investors enough information to make a sound judgment, it would work for them and for us.16 The idea was to issue a long-term roadmap indicating not only a destination (in this case, an EPS target), but also the path to reach that destination. Toward that end, the finance team built a financial model underlying the roadmap, complete with cash flow generation and distribution via dividends and share repurchases. Palmisano described the process this way: You need to start with the strategy. Ours was to migrate to higher margin, highervalue businesses. To exit commoditizing stuff and get into areas we felt were generative: analytics, the cloud, big data, etceteraa lot of software. Then we had to translate that to a financial model so that the investor could say, "That strategy works for me." Then we had to translate the financial model into a management system, and every unit had to have a plan to execute that road map. And then we had to put a compensation system in place that reinforced that success.a . . . Last, people need to understand that if they execute the model, they will be rewarded. . . . So it started with the strategy, and it was completely plumbed, end to end.17 Palmisano said, "We had to get ourselves comfortable internally so we could be credible and specific."18 As the comfort level rose, the firm disclosed its strategy for value creation in two new ways. First, beginning in 2006, IBM disclosed its strategic plans in its annual report in a section called, "Generating Higher Value at IBM." In subsequent years, it published annual updates and refinements to help investors understand where the firm was headed and how it was going to get there. For example, the 2007 report said: Several years ago, we saw change coming. We remixed our businesses in order to move to the emerging higher-value spaces. And we decided to become a globally integrated enterprise in order to participate in the world's growth markets and improve IBM's productivity. As a result, IBM is a higher performing enterprise today than it was a According to IBM's 2008 Proxy Statement (dated 3/10/08, pp. 23, 19), the board's compensation committee noted the following achievements, among others, when setting compensation for CFO Mark Loughridge (who preceded Martin Schroeter): "Developed long-term EPS roadmap to 2010 to enhance investor understanding of financial model" and "Exceeded Net Income and EPS objectives." At the same time, the firm's Long-Term Incentive Plan (LTIP) rewarded senior executives based on two key financial metrics (EPS and cash flow) over a three-year period. 4 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. Generating Higher Value at IBM (A) 215-058 a decade ago. That has enabled us to invest in future sources of growth and provide record returns to investors. . . . This gives us confidence we can achieve our long-term financial objectives.19 The second part of the disclosure strategy was the "EPS Roadmap." At the investor briefing on May 17, 2007IBM held investor briefings every year involving the entire leadership team Palmisano announced the "2010 Roadmap." As a destination, the firm set an EPS target of $11.00 in 2010 from a baseline diluted EPS figure of $6.11 in 2006. The almost $5.00 increase in EPS would come from five sources: $0.75 from base revenue growth; $1.20 from future acquisitions and growth initiatives; $1.00 from margin expansion; $1.10 from share repurchases; and $0.90 from reductions in post-retirement-related costs.20 During the all-day briefing, senior executives described initiatives that would enable the firm to meet this goal. The next day, when this news reached the market, IBM closed at $107.99, up 2.54% on a day the S&P 500 was up 0.66%. After hearing the presentation, an equity analyst at Canaccord|Adams said: The event provided us with an opportunity to gain insight into IBM's long-term strategy and divisional goals until 2010. . . . A key highlight of the event was the granularity provided in regards [sic] bottom-line growth expectations to 2010. . . . The clarity on the long-term strategy confirms our expectations for management to drive a strategic change in revenue mix and margin improvement. IBM's balance sheet strength through its ability to pursue aggressive growth through acquisitions and share buybacks provides further upside to our estimates. Hence, we reiterate our BUY recommendation.21 An analyst at Deutsche Bank said: IBM outlined a convincing plan for sustainable top and bottom line growth. . . . Following this meeting, we have greater confidence in both the short-term and longterm EPS potential for the company. IBM's goal of driving 16% EPS CAGR through 2010 was above its historic guidance (+10-12%) and our expectation.22 Not all of the analysts, however, were convinced by the plan or the firm's ability to achieve its EPS target. For example, the research team at JP Morgan said: Surprisingly, the company . . . laid out a fairly detailed roadmap for its potential EPS expansion through 2010. . . . IBM was clear to note that this was not a change in guidance, but rather a map of its long-term profit expansion goals. . . . Given our concerns over the company's ability to maintain its competitive position in key hardware segments and further expand its services profits, we are somewhat skeptical of the company's longer-term growth and profit targets. . . . We are maintaining our Neutral rating.23 Just after announcing the EPS Roadmap, IBM began to execute the plan. On May 29, 2007, the firm announced that it had borrowed $11.5 billion and used the proceeds plus balance sheet cash to buy 119 million shares (8% of the total outstanding) through an "accelerated share repurchase" agreement.24 Under the agreement, IBM bought the shares from three investment banks at a price of $105.18 per share.25 Reflecting on this and subsequent open-market repurchase transactions, CEO Palmisano said: "These stock repurchases are enabled by IBM's strong, consistent cash flow and are an important way of returning value to IBM shareholders. They are an element of our long-term roadmap for earning per share growth through 2010 and represent a good value at today's prices."26 5 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. 215-058 Generating Higher Value at IBM (A) Financial Performance: 2006-2009 Over the next three years, from 2006 to 2009, the firm's financial performance improved dramatically. For the year ending 2009, revenues were up 5% to $95.8 billion and net income was up 41% to $13.4 billion. The increased profitability was due to a combination of efficiency improvementsgross, operating, and net margins all improved by at least 3%and to a more profitable business mix due to further acquisitions and divestitures as well as organic growth. As profitability improved and the number of shares outstanding fell due to buybacks (the weighted average number of diluted shares fell by 14%), the firm's diluted EPS increased from $6.05 in 2006 to $10.01 in 2009. What was particularly striking about the 2008 and 2009 results was that they occurred during the midst of the global financial crisis. This prompted one equity analyst to exclaim, "Big Blue Blockbuster. . . . I have never seen anything like that in the years I have been following IBM. In an unpleasant economic and financial world, these are incredible results."27 At the firm's May 2010 investor briefing, CFO Mark Loughridge (who preceded Martin Schroeter) analyzed the firm's financial performance through 2009 against the original 2010 roadmap and asserted that IBM was on track to meet its EPS goal of $11.00 by year end (see Exhibit 5a). The 2015 EPS Roadmap After declaring victory on the 2010 roadmap before actually closing the books on 2010, the leadership team issued a new EPS roadmap for 2015 at the investor briefing in May 2010. Going forward, however, CFO Loughridge said the firm would start reporting the roadmap using operating (non-GAAP) EPS, which for 2010 would likely be $11.35 (non-GAAP) vs. $11.21 (GAAP).28 The primary difference between the two numbers was that operating EPS excluded acquisition-related charges and certain retirement-related expenses. According to Loughridge, operating EPS provided greater transparency on operating results, enabled more accurate comparisons with peer firms, and allowed for a better long-term view of the core business.29 Although Loughridge announced the 2015 EPS roadmap based on expected financial results for 2010, he amended the plan slightly in early 2011 after IBM released its actual results for the year. Loughridge said the target for operating EPS in 2015 would be at least $20 per share. The $8.35 increase in EPS (= $20.02 EPS target minus the actual operating EPS of $11.67 in 2010, up from the forecast EPS of $11.35 when the 2015 roadmap was first announced) would come from six sources: $1.45 from base revenue growth; $0.70 from revenue mix (shift to high-growth businesses); $0.90 from acquisitions; $0.75 from margin mix (shift to high-margin businesses; $1.75 from enterprise productivity; and $2.80 from share repurchases.30 The first three sources were related to revenue growth, the next two were related to margin expansion, and the last one resulted from the reduction of shares outstanding. They totaled $3.05, $2.50, and $2.80, respectively (see Exhibit 5b). Loughridge explained the creation of and motivation for the new 2015 roadmap: It began as a communications tool, a way to articulate both strategic and tactical goals so investors would have more clarity, but soon we were using it internally for all kinds of goal-setting, because it really helped us look well beyond the next quarter. It was very galvanizing, so as we reached the end of the period covered by that [the 2010] map, we developed a new one through 2015. The first version was created top-down, but the one we're operating under now was developed bottom-up. . . . The power of the roadmap is that it is not simply a financial plan. It is owned by every leader in the business who is accountable for results, and that includes my team. It's a bottom-up 6 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. Generating Higher Value at IBM (A) 215-058 approach planned with, plumbed through, and executed at every level of the business.31 Overall, investors reacted positively to the 2010 investor briefing: IBM increased from $126.89 to $132.68 (up 4.6%) on a day the S&P 500 was up 1.4%. Following the presentations, the analyst team at Deutsche Bank wrote: IBM outlined a credible roadmap to generate operating EPS of $20+ by 2015. . . . We believe the 2015 goals are achievable, particularly in light of management's strong operational track record where it delivered its prior LT 2010 EPS target. . . . We also believe there is some conservatism embedded in the target, particularly for assumptions around cost savings yield, accretion from acquisitions and revenue.32 The analyst team at JP Morgan called the new roadmap "compelling," and commented on the transition to and future use of operating EPS instead of GAAP EPS numbers: "We think this move will be viewed favorably by investors, putting IBM on par with its peers such as HP, EMC, and Dell. In our view, the move also signals that IBM stands to continue its prolific acquisition pace."33 As before, not all of the analysts were convinced by the presentation. The research team at Credit Suisse expressed a more cautious tone: [T]he clarity with which the company laid out its roadmap and management's consistent reminders that there is potential for even further upside clearly provided a healthy boost to investor sentiment. Overall, considering the company's performance versus the prior roadmap, management certainly has the credibility for such a long-term forecast. . . . While we have underestimated IBM's earnings power in the past, we are not increasing our estimates at this time. We may be too conservative on IBM's costcutting capabilities, but our sense is that the long-term model may not fully consider the risks of an increasingly competitive enterprise marketplace in coming years.34 Leadership and Shareholder Changes Over the next three years, IBM experienced two major leadership changes and one significant change in its investor base. Virginia Rometty replaced Sam Palmisano as CEO in January 2012, and Martin Schroeter replaced Mark Loughridge as CFO in January 2014. Schroeter described IBM as "a very powerful cash generating machine [with] . . . a willingness to redeploy [cash] both back into the business as well as return money to shareholders."35 When deciding how much cash to distribute, Schroeter described a hierarchy of uses for the firm's cash flow: When we think about how we deploy our capital, we think about it in a pretty ordered way. So, first, we . . . allocate our cash flows to make sure that we have our capex investments in place and [are] sufficient to drive the opportunity we see. Secondly, we are acquisitive. [We buy] . . . things, again, consistent with where we see enterprise computing and supportive of our strategy. We don't buy things to try to change who we are. . . . Third, we pay a dividend. . . . And then we have excess capital. . . . [I]t's our job to deploy it; it's not to hold on to it. [In terms of setting the dividend, we . . . ] look at payout ratios relative to what others are doing [and relative to our profits]. We don't think about it from a yield perspective, but we do think about payout ratios. But most importantly, we think about our ability 7 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. 215-058 Generating Higher Value at IBM (A) over the long term to continue to pay a dividend. And obviously we feel quite good about that, because we view it as something we're always going to do.36 In addition to the leadership changes, IBM also gained a very prominent new investor: Warren Buffett. Buffett's investment in IBM was a somewhat unusual and quite unexpected move given his long-standing reluctance to invest in technology firms and his historical preference for value (not growth) firms. During a televised interview on CNBC's Squawk Box, Buffett revealed that he owned $10 billion worth of IBM stock (about 5.5% of the company) and explained why: I don't think there's any company . . . that's done a better job of laying out where they're going to go and then having gone there. They have laid out a road map and I should have paid more attention to it five years ago. . . . Now they've laid out another road map for 2015. They've done an incredible job. . . . [Moreover] they have this terrific reverence for the shareholder, which I think is very, very important.37 Financial Performance: 2010 to the First Quarter of 2014 Over the next three years, senior leaders updated investors at the quarterly earnings presentations on the firm's progress toward the 2015 EPS goal of $20 per share. The results for 2013 showed IBM was making progress toward its stated goal, but with some challenges along the way. From 2010 to 2013, revenues were flat, net income was up 11% to $16.5 billion, and operating profit (the non-GAAP measure) was up 20% to $18 billion. Once again, the firm's gross, operating, and net margins had all improved, and the number of shares outstanding continued to fall because of share repurchases. One reason the net margin had increased was that the firm's effective tax rate had been reduced to 15.6% due to a combination of factors including favorable geographic locations, completion of a tax audit and reversal of prior reserves, and an increase in R&D tax credits, among others.38 As net income rose, operating (non-GAAP) EPS rose from $11.67 per share in 2010 to $16.28 in 2013, a 40% increase in three years (see Exhibit 5b). Despite this performance, IBM announced somewhat mixed results for the first quarter of 2014. (Exhibit 6 shows quarterly financial results for 2012, 2013, and the first quarter of 2014.) The firm's press release on April 16, 2014, read: First-quarter net income was $2.4 billion, down 21 percent year-to-year. Operating (non-GAAP) net income was $2.6 billion compared with $3.4 billion in the first quarter of 2013, a decrease of 22 percent. . . . Total revenues for the first quarter of 2014 of $22.5 billion were down 4 percent . . . from the first quarter of 2013.39 At the earnings conference call, Schroeter said: IBM's revenue was down 4%...[down 2% adjusted for currency movements, but] we improved gross margin by 130 basis points, driven by services and our ongoing mix to software. . . . As we look to the balance of 2014, we continue to expect good performance in the key growth areas, though our overall revenue growth will be impacted by the challenges in our hardware business. . . . For the year, we expect to deliver at least $18 of operating earnings per share. . . . Like always, we manage our business and allocate capital for the long term, and along the way, we still expect to deliver at least $20 of operating EPS in 2015.40 Like Schroeter, Rometty painted a relatively optimistic picture of the future: 8 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. Generating Higher Value at IBM (A) 215-058 In the first quarter, we continued to take actions to transform parts of the business and to shift aggressively to our strategic growth areas including cloud, big data analytics, social, mobile and security. As we move through 2014, we will begin to see the benefits from these actions. Over the long term, they will position us to drive growth and higher value for our clients.41 Investor Briefing on May 14, 2014 One month later, on May 14, 2014, IBM held its annual investor briefing. Prior to the event, several analysts wrote reports describing their expectations for the firm and its stock price (IBM was trading at $190 per share at the time). For example, the analyst at Cantor Fitzgerald said: [W]e believe IBM's stock has healthy upside potential, as reflected in our [$220] price target. . . . we expect . . . [CFO Schroeter] to reiterate the company's 2015 EPS outlook of at least $20.00 . . . [and] we expect deep conversations around the major disruptive forces (e.g., cloud, Big Data, mobile Internet) occurring in the IT market and the impact these trends are having on IBM's business.42 In contrast, the analyst team at Barclays was more skeptical and, as a result, had a lower price target of $173 per share: IBM is at a critical juncture given the shift in IT towards the cloud and softwaredefined environments. While IBM is likely to keep its 2015 earnings target, we evaluate IBM more on cash flow than earnings and view its roadmap as less important. . . . [W]e believe it makes sense for IBM to abandon its roadmap entirely and change its business model given these threats that have emerged.43 Despite the downturn in the first quarter, and the rising chorus of analysts with concerns about IBM's prospects, the management team sounded upbeat at the investor briefing. Rometty once again emphasized the ongoing transformation and the importance of the roadmap: We hear from you (our investors) that the roadmap is important because it is both a transparent view of our capital allocation model and it is also a demonstration of us running this company for the long term. . . . And it has a result which is an EPS number, but that is just a result. The roadmap is a manifestation of a business strategy.44 Schroeter, during his presentation, reiterated the $20 EPS goal and described the path to it: We've got . . . very good growth out of software, very good growth out of services, and we've got challenges in hardware which we've talked about. Now we think we have addressed those. . . . We still do see at least $20 in 2015. . . . This is just a stop along the way if you will. . . . We run for the long-term.45 Schroeter then described the path to $20 starting from the current operating EPS of $16.28 in 2013: the firm would add $2.00 from share repurchases and $3.25 from revenue and efficiency gains, but lose $1.50 from "tax headwinds" (an increase in the effective tax rate) for a total EPS of $20.03 in 2015.46 Following the briefing, few analysts moved away from their previous positions: Cantor Fitzgerald kept its price target at $220, while Barclays kept its price target at $173. Between these two outliers was the analyst team at Wells Fargo, which had a price target of $180 and considered IBM to be a "fairly defensive stock given its historical track record of meeting and exceeding guidance . . . and its 9 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. 215-058 Generating Higher Value at IBM (A) recurring revenues," 47 and the analyst team from BMO Capital Markets, which had a higher price target of $195, even though it appeared more critical of the firm, its strategy, and its prospects: Given that IBM continues to generate low-quality earnings through buybacks and tax rates, we question if establishing annual and long-term EPS targets are constructive for the long-term health of the shares. We wonder if IBM would be better 1) selling assets more aggressive[ly] . . . , 2) investing more aggressively to drive higher long-term organic growth, and 3) not relying on tax rates and share count (and driving up the debt balance) to make EPS estimates. In other words, we question the actions such long-term EPS targets drive.48 Bernstein Research analyst Toni Sacconaghi, who had a "market perform" (hold) recommendation on IBM and a target price of $180, also questioned whether the roadmap had outlived its usefulness: IBM's EPS bogey now appears viewed as an interesting place holder and increasingly decoupled from the fundamentals of its business. . . . If the $20 EPS bogey is no longer relevant, why did CEO Ginni Rometty and new CFO Martin Schroeter recently choose to uphold it? Many investors believe that unleashing the shackles of the 2015 EPS target might enable IBM to invest more and make selective high value acquisitions, rather than look to cost cut and repurchase shares....so why is IBM steadfastly driving to its roadmap? It is hard to say. Perhaps IBM genuinely believes it can invest and do what's right for the business while simultaneously achieving its roadmap.49 Conclusion That night as she reviewed her notes from the day, Johnson made a series of calculations regarding IBM's cash generation and capital allocation relative to its peers (see Exhibit 7) and then updated the key assumptions in her own financial model for IBM's future earnings. Based on her analysis, Johnson wondered if it was time to change her "hold" recommendation. The stock price closed down on the dayit had fallen slightly from $192 to $189 per shareand short interest was up slightly though still relatively low on an absolute basis. She knew most of her peers had issued "hold" recommendations before the meeting and had made only minor revisions to their price targets following the release of the firm's 2013 results (see Exhibit 8), yet now she wondered how many of her peers, if any, would move their recommendations based on what they had heard that day at the investor briefing. If she were going to change her investment recommendation, Johnson not only wanted to be ahead of her peers, she also wanted to be right. 10 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. Generating Higher Value at IBM (A) 215-058 Appendix A: Mechanisms Firms Use to Distribute Cash to Shareholders Firms traditionally use two mechanisms to distribute cash to shareholders. Under the first mechanism, dividends, the firm pays cash to all shareholders on a per share basis. These cash payments can be done a recurring basis (regular dividends) or on a one-time basis (special dividends). The most common form of regular dividend is a quarterly dividend. Under the second mechanism, share repurchases (or "share buybacks"), the firm uses cash to buy shares from selling shareholders and can then either retire the repurchased shares or classify them as "treasury stock" meaning they are available for re-issuance. To make economic sense, the repurchase price should be equal to or less than firm's fundamental equity value (i.e., current market price). Share repurchases can be accomplished in many ways. First, the firm can buy shares on the open market at market prices ("open market" repurchase). Alternatively, the firm can make a tender offer with a fixed price, often at a premium to market prices, and a fixed date ("tender offer" repurchase). Under certain circumstances, a firm may use a "Dutch Auction" to repurchase its shares. In this kind of auction, the firm picks a target number of shares to repurchase and then provides a price range over which it will buy the shares. Shareholders submit the price and the corresponding number of shares they are willing to sell. The firm then picks the lowest price that will allow it to buy the desired number of shares. A fourth kind of repurchase is a "targeted" or "negotiated" repurchase whereby the firm buys shares from a single or small number of shareholders. This approach is typically used to thwart a hostile takeover and is pejoratively referred to as "greenmail" as it is done at a premium to market prices. A fifth and relatively new kind of repurchase is the "accelerated share repurchase." Under this kind of buyback, a company buys all the desired shares from an investment bank, which obtains the shares through a short sale (the investment bank does not own the shares but rather has borrowed them). The investment bank then buys shares on the open market to cover its short position. For the company, the advantage of an accelerated share repurchase is that it completes the repurchase quickly, thereby improving its reported earnings per share. The sixth and final way to repurchase shares, albeit a relatively uncommon way, is the transferable "put right." Here the firm gives shareholders the option (the right but not the obligation) to sell a share of stock back to the firm at a set price by a given date. Despite the existence of many ways to distribute cash to shareholders, the two basic mechanismspaying cash or buying sharesdiffer in some fundamental ways. First, dividends are taxed as ordinary income and share repurchases are taxed at short- or long-term capital gains rates depending on the investor's holding period. Historically in the United States, tax rates on ordinary income were higher than rates on capital gains. Since the Tax Relief Act of 2003 equalized these two rates, the tax advantage of repurchases has been reduced, though investors still have the ability to defer taxes by not selling their shares. Second, whereas all shareholders receive dividends when they are paid, only a subset of shareholdersthe selling shareholdersreceive cash from repurchases. A third difference is that the payment of dividends does not change the firm's ownership structure. In contrast, share repurchases do change the ownership structure because they reduce the number of shares outstanding. Source: Casewriter. 11 This document is authorized for use only by Anna Osmanai in Hybrid Fall 2019 taught by DAVID RODRIGUEZ, High Point University from Aug 2019 to Feb 2020. For the exclusive use of A. Osmanai, 2019. 215-058 Generating Higher Value at IBM (A) Appendix B: Total Dividends vs. Stock Repurchases for Public Firms, 1971-2013 ($ billions) Source: Casewriter analysis based on data from Compustat, accessed 2/17/15. Appendix C: Summary of Financial Executives' Views on Payout Policy Dividends Repurchases Historical level Very important. Do not cut dividends except in extreme circumstances. Not important. Flexibility Consequence if reduced Sticky. Inflexible. Smooth through time. Big [stock] market penalty for reducing or omitting. Target [level] Most common target is the level of dividend, followed by the payout ratio and growth in dividends. External funds would be raised before cutting dividend. Very flexible. No need to smooth. Little consequence to reducing from one year to the next though firms try to complete [announced] plans. Most common target is the dollar amount of repurchases, a very flexible target. Repurchases would be reduced before raising external funds. First maintain historic dividend level, then make incremental investment decisions. First make investment decisions, then make repurchase decisions. Tax disadvantage of dividends of secondorder importance. Dividends convey information about future prospects. Tax advantage of repurchases of secondorder importance. Repurchases convey information about future prospects. Not important. Repurchase shares when stock is undervalued by market (Price