A historically significant development occurred in late July that flew under most people’s radar. IBM offered $1 billion of 10-year corporate bonds on July 25, and the bond issue sold out at a new 10-year record low rate: 1.875%.
I can guarantee that most of you are scratching your heads wondering: “Fine, but what’s the big deal?”
Thanks for asking! The “big deal” is this:
1) IBM has a history of knowing exactly when to borrow at interest rate “bottoms”;
2) This is the third record low corporate bond rate IBM has snapped up this year:
a. It sold $1.5 billion of three-year bonds in February for a puny 0.55%;
b. It sold $600 million of seven-year debt in early May, paying only 1.875%.
That may not seem like a big deal to most folks. However, in financial circles, that is an “amazing deal”.
To put this in more concrete terms, consider this:
IBM could (if it chose) use that newly garnered $1 billion to buy approximately 5.037 million shares of its own stock(at Friday’s closing price of $198.52) and hold the stock for ten years. As long as IBM continues to grow its quarterly earnings by at least its current 5.9% rate, and there is no catastrophic financial crash that destroys IBM in the coming decade, IBMwould come close to covering its entire debt servicing cost for the bond through the reduction of dividend expense achieved by buying back its own common stock. (IBM’s current dividend yield is approximately 1.8%!)
For those who know finance, that is amazing. It beautifully illustrates how extremely low interest rates are relative to equity, and why even the most anxious investor shouldn’t have all their money in fixed income instruments. Someday (sooner or later) interest rates will start trending upward, and perhaps trend rapidly and significantly upward – slashing the value of fixed income investments!
Disclosure: I do not own IBM shares and I do not herein offer recommendations to buy or sell any particular investment.
Submitted by Tom Petty
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