Warren Buffett (Trades, Portfolio)’s announcement he had sold around a third of his position in International Business Machines Corp. (IBM, Financial) shocked many Buffett watchers and proved many IBM doubters right. Whatever your view may be on IBM and the company’s slow transition, it is interesting to see how Buffett’s view of the company has evolved over the past six years. If anything, his comments and actions are a great lesson to investors on how to manage a disruptive position.
Let’s start at the beginning. Buffett’s IBM position was first announced in 2011. He justified the the position in Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) 2011 annual shareholder letter:
“I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock. Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?
I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years.
Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the 'disappointing' scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $11â„2 billion more than if the 'high-price' repurchase scenario had taken place.
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In the end, the success of our IBM investment will be determined primarily by its future earnings. But an important secondary factor will be how many shares the company purchases with the substantial sums it is likely to devote to this activity. And if repurchases ever reduce the IBM shares outstanding to 63.9 million, I will abandon my famed frugality and give Berkshire employees a paid holiday.
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As was the case with Coca-Cola (KO, Financial)Â in 1988 and the railroads in 2006, I was late to the IBM party. I have been reading the company’s annual report for more than 50 years, but it wasn’t until a Saturday in March last year that my thinking crystallized. As Thoreau said, 'It’s not what you look at that matters, it’s what you see.'”
Rather than returning $50 billion to investors via buybacks over the next five years, however, IBM abandoned its earnings growth roadmap and dialed back repurchases for a larger dividend. Management also decided to devote more money to bolt-on acquisitions and, with debt mounting, decided to reduce overall shareholder returns as the top line continue to deteriorate.
Still, as his initial thesis fell apart, Buffett remained adamant he had made the right decision despite IBM’s languishing stock price. At the end of February last year when asked about IBM’s falling shares on CNBC, Buffett replied:
"What you pay for a stock doesn't mean anything. What means something is where the company's going to be in five to 10 years. I think IBM will be worth more money but, like I said, I could be wrong but we'll accept that."
And as Reuters reported, he then went on to say Berkshire was considering adding to its IBM stake:
“Warren Buffett, chairman and chief executive of conglomerate Berkshire Hathaway, said Monday he would be more likely to buy than sell IBM shares over the next two years...
Buffett, who presided over Berkshire's 51st annual shareholder meeting in Omaha, Nebraska over the weekend, told cable television network CNBC: 'We would be much more likely to buy more in the next 12 or 24 months than we would be to sell shares, but we will make that call as time goes along.'"
One year and it seems everything has changed. Rather than adding to the position, Buffett has begun to sell his IBM holding. As the company continues to struggle, there could be further sales on the table.
Discussing his decision to sell down the position in an interview with CNBC last week, Buffett said:
“I don’t value IBM the same way that I did six years ago when I started buying.”‰I’ve revalued it somewhat downward. IBM is a big, strong company, but they’ve got big strong competitors, too.”
What has changed in the past six months? We do not know, but what is clear is something big made Buffett, the world’s most patient long-term investor, suddenly changed his entire thesis on a company almost overnight.
This sudden change of heart has worrying implications.
Disclosure: The author owns no stock mentioned.
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