Is Old Tech The New Annuity?

A question from a friend got me thinking about the capital allocation strategy of established technology companies.  "Old tech" has become incredibly efficient at generating profits and returning those profits to shareholders in the form of share repurchases.  In other words, they have essentially become corporate annuities that generate a cheaper profit stream that U.S. Treasury bonds.

I pulled various information for Intel (INTC), Microsoft (MSFT), Cisco (CSCO), IBM (IBM), and Hewlett Packard (HPQ).  The following summary is for the five year period from 2006 to 2010:

• Cumulative Net Income for all companies was $244.4 Billion
• Cumulative amount spent on share repurchases for all companies was $238.6 Billion

These five companies spent 97.6% of their combined Net Income on share repurchases over the last five years! Now, what happened to their share counts during that time?  Over the last five years, the decline in shares outstanding (fully diluted) for each company were:

• IBM      20.91%
• HPQ     18.46%
• MSFT   18.15%
• CSCO  11.55%
• INTC    7.80%

Intel has spent the least amount (both on an absolute basis as well as a relative basis) on share repurchases, but they had two years when they spent over $1 Billion on share repurchases and the fully diluted share count actually increased.  That's not that exciting.

What is perhaps the most impressive is that while IBM spent 5 years and almost 100% of their Net Income to buy back 20.91% of the company their annual net income almost doubled to $14.88 Billion.  Hewlett Packard and Microsoft have also been able to buy back substantial blocks of their respective companies while substantially growing earnings over the last five years.

The 10-year treasury finished today with an annual yield to maturity of 3.134% - an implied P/E ratio of 31.9x for guaranteed zero growth.  These five tech established tech companies trade between 9.14x and 14.13x earnings, are returning substantially all Net Income to shareholders, and are growing earnings at various rates.

While I do not own any stock in these companies, I do own TBT which is short U.S. Treasury's.

What I Learned From Senator Alan Simpson

"After all the talk about debts and deficits, it is long past time for America's leaders to put up or shut up.  The era of debt denial is over, and there can be no turning back.  We sign our names to this plan because we love our children, our grandchildren, and our country too much not to act while we still have the chance to secure a better future for all our fellow citizens"
      - Concluding paragraph of the Preamble from The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform

Zions Bank hosted former Senator Alan Simpson (R-WY) last month as part of the Zions Premier Wealth Management Speaker Series.  He spoke at a "tax day" event about the national debt and current efforts in Washington to reverse fiscal policy trends that have our country facing an uncertain economic future at best and bleak circumstances down the road at worst.  I learned at least two things from Senator Simpson:

1. There is hope for those of us that want a more civil political dialogue
2. Our country's fiscal problems are so large that they will require a more civil conversation in order to address them

Two days before the Simpson event, President Obama gave a major policy speech where he unveiled his deficit reduction plan which was far different than the commission report.  Prior to his speech, the Washington Post reported that the President was going to embrace the report from the National Commission on Fiscal Responsibility and Reform (which was co-chaired by Senator Simpson).  This was news because the President had basically ignored the report of his own commission until that time.  However, simply speaking, he did NOT embrace the report.  Senator Simpson came to Utah directly from Washington D.C., and I expected a lot of direct, plain spoken criticism about what was wrong with Washington.  However, what we heard in his speech and in private conversations was the exact opposite.  We heard about hope based on the fact that people were still talking, and we didn't hear one criticism for anyone who was engaged in the process.  We received a plea to pray for those who are working in a bi-partisan way to overcome the challenges we face.  We heard praise for the Republicans and Democrats who were working together, and I sensed some real disdain for the extreme ideology of both parties.  I heard hope in a more civil political dialogue.

The fiscal problems we face are enormous.  Federal debt is rising, and at some point (we don't really know where) it impacts all of us through higher interest rates, limited economic growth, reduced flexibility, and increased exposure to foreign creditors.  A few items according to the commission report and recent events:

1. During 2010, as a percentage of GDP, federal spending was 23.8% and tax revenue was 14.6% resulting in a deficit of 9.1% of GDP
2. The federal debt, as a percentage of GDP, has risen from 33% in 2001 to 62% in 2010
3. This week, the Treasury reached the legal threshold of total allowable debt outstanding.  We are currently operating on "technical measures" to avoid default.  These technical measures give our political leaders until the beginning of August

The size and scope of the problem suggest that a solution will only be found as majorities from each party create a more civil political dialogue.  We need ideas, commitment, and especially sacrifice.  The solution will only come from mutual trust on the part of politicians who stop attacking and start talking.  There is hope now that the plans have been released publicly and discussions are occurring.  The "Gang of Six" in the Senate continues to work.  I am hopeful they will be successful.  Am I naive?  I probably am, but Senator Simpson reinforced my hope that a solution exists to this problem.