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IBM's Accounting Deserves Scrutiny, But the New York Times Story Sounds Like...

A Big Blue Red Herring

JDS Sale: Small Fry; Bigger Fish Should Be Checked

PHOENIX, Feb. 15 - A New York Times story that knocked off over $9 billion (nearly 5%) of the Big Blue value this morning may be a red herring. At least that's the way it looks to us (see "As It Beat Profit Forecast, I.B.M. Said Little About Sale of a Unit," the New York Times, Feb. 15, 2002).

The Times said that IBM used a one-time sale of assets that should have been reported as "Other Income" to pad its earnings: 

"... some investors had begun to wonder whether I.B.M.'s quiet sale of its optical transceiver business to JDS Uniphase on Dec. 28, the last Friday in 2001, was intended to help the company over the earnings bar. JDS agreed to pay I.B.M. $340 million in shares and cash, a price that is nearly five times the business's sales. On Jan. 17, when I.B.M. announced its fourth-quarter results, there was no disclosure about the amount generated by the sale or the company's accounting of it."

How can we be sure this is a Big Blue "Red Herring?"  We can't. Not until IBM opens up its books to independent outside scrutiny. Which may be some time after hell freezes over.  But the preceding Times allegation fails the test of common sense.  And that's why we think the JDS sale is a small fry story; that would-be investigators of IBM's accounting practices, of "financial engineering" as we have been calling it for years, should be checking out some bigger fish.  

Meanwhile, back on the ranch... why did the JDS story fail our test of common sense?  Because it did not change the IBM bottom line.  And because IBM did not do anything illegal.  Thus the Times' allegation that the JDS sale "was intended to help the company over the earnings bar," was at best - inaccurate.  The IBM earnings were down anyway (see "IBM Stock to Take a Dive" - Gerstner’s Worst Fourth Quarter; Sharp Drop in Revenue, Profit , Jan. 18, 2002).

Second, all the fuss raised by the story is about midsection accounting of income statements.  In other words, whether income is reported as "Other Income" or "Operating Income" did not affect the bottom line.  In the early 1980s, for example, IBM sold off tens of billions of dollars of its rental inventory assets, thus padding its earnings by more than $7.5 billion (see the Annex Bulletin "IBM: Mortgaging Its Future," March 1983).  Yet the marketplace basically shrugged it off.

Nowadays, all IT services companies that engage in outsourcing, not just IBM, have to make similar accounting calls... whether to classify profits/losses from certain asset sales as operating or "other income/expense" items.  Such decisions depend on a myriad of factors, including tax issues.  They are an art, not science.  They are also routine.

Those who want to question IBM accounting practices, or its "financial engineers," should leave such small fry alone, and look for bigger fish elsewhere.  Such as in its tax accounting... pension plan (ab)uses... stock buybacks... insider trading... etc. 

Happy bargain hunting!

Bob Djurdjevic

[For more details on "financial engineering" -- a new IBM line of business, as we put it back in 1997 -- see Is IBM Cheating on Taxes, Annex Bulletin 99-17 (May 1999),  Fortune on IBM (June 15, 2000)Annex Bulletin 98-14 ("Wag the Big Blue Dog"), Armonk's Fudge Factory (Apr. 9, 1999)Where Armonk Meets Wall Street, Greed Breeds Incest (November 1998)Stock Buybacks Questioned: Is IBM Mortgaging Its Future Again?, 97-18 (4/29/97),  "Some Insiders Cashed In On IBM Stock's Rise, Buybacks" 97-22, 7/27/97,  Djurdjevic’s Forbes column, "Is IBM Back?," 6/10/97; "Corporate Cabbage Patch Dolls," 98-39, 10/31/98; Djurdjevic’s Chronicles magazine October 1998 column, "Wall Street Boom; Main Street Doom" etc.].

Or just click on and use "financial engineering" as keywords.


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Volume XVIII, Annex Newsflash No. 2002-01
February 15, 2002

Editor: Bob Djurdjevic
Published by Annex Research

P.O. Box 97100, Phoenix, Arizona 85060-7100
TEL/FAX: (602) 824-8111

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