While much of the financial media are cheering the large earnings beat and price jump of IBM, there are some who tell it like it is in a market-politically-correct sort of way.

Therese Polleti of MarketWatch provides the rest of the story in her article IBM earnings beat is a product of tax avoidance, and it’s nothing new. Here are some of the details she provides us:

IBM managed to beat expectations for profit and sales despite revenue declining for a 22nd consecutive quarter, to $19.15 billion from $19.22 billion a year ago.

All companies beat expectations since they drive those expectations down just so they can beat them.  It’s the revenue that gives it away.

The company’s profit also topped analyst estimates, at $2.92 a share against average expectations of $2.84 a share, thanks to an astonishingly low effective tax rate of 11%. Yes, you read that right, while the average American citizen pays about 30% of their income in taxes, IBM paid 11% of its profits out to governments in the third quarter, in which net income was more than $2.7 billion.

Most U.S. corporations reduce taxes through various loopholes and money-losing divisions, corporate restructurings and other write-downs. Many also park revenue earned overseas in the country it was earned, rather than move those funds back to the U.S. and pay more taxes.

In IBM’s case, a discrete tax benefit of $582 million related to an intra-entity asset transfer — shuffling non-inventory like intellectual property between business units, an exercise for which accounting practices are changing and IBM chose to adopt the new approach early — gave it an effective tax rate of negative 23.1% in the first quarter of 2017, according to a regulatory filing. 

These accounting practices are “changing” why?  Just maybe because countries are trying to crack down on shifting intellectual property to avoid paying taxes.

President Donald Trump has heralded a reduction in the 35% corporate tax rate as a way to help businesses and investors, with a targeted rate of 20%. IBM is already effectively paying less than 20% in global taxes, however, while raking in billions in profit and pushing a good portion of that money back out in stock buybacks to further cushion its earnings.

Buybacks do NOT cushion earnings, they pad Earnings-Per-Share by reducing outstanding shares. It just shows that lower tax rates will be plowed back into share buybacks which does nothing for the economy and everything for wall street and CEOs.

But it is nothing new, Apple has been doing this for a long time as the New York Times reported in 2013.

Transfer pricing is an issue in all multinational companies and can be used to move profits from one country to another, but it is especially hard for countries to monitor prices on intellectual property, like patents and copyrights. There is unlikely to be a real market for that information, so challenging a company’s pricing is difficult.

“It is easy to transfer the intellectual property to tax havens at a low price,” said Martin A. Sullivan, the chief economist of Tax Analysts, the publisher of Tax Notes. “When a foreign subsidiary pays a low price for this property, and collects royalties, it will have big profits.”

So whether you agree that corporate taxes should be eliminated or lowered or not, the point is IBM did not pop on fundamentals, but on tax avoidance through common accounting gimmicks.  I guess the financial engineering from share buybacks wasn’t doing the trick anymore.

On the pension side, IBM did not make any contributions to their pension fund in 2016 and 2017 because it is 98% funded.  Meaning they had no pension expenses the last two years.  Which is great unless the market tanks which would require them to start making contributions again.  Which would increase their expenses, which leads to lower profits down the road.

In other words, their current profits are not burdened by a pension expense and that is not sustainable. Which is another positive accounting feedback loop that turns negative in a downturn.

Now about the declining revenue.

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Categories: Perspectives