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Author: justpatrick Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 9296  
Subject: Re: Smoke & Mirrors Date: 5/31/2001 1:43 PM
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janetpuppy,

Sorry this is long, but it takes more time to support a change to an idea than to put one out there. :)

I addressed some of these issues in a previous post:

http://boards.fool.com/Message.asp?mid=14980917

I would contend that 1) Your assumption that these profits are "Vapor" profits is incorrect. 2) Actuarial assumptions do not change reality. 3) Your math on the impact of these profits is incorrect. (not that you divided wrong, but that you were dividing the wrong numbers).

Point 1) Why are these not "Vapor" profits?
They are NOT taking money out of the pension plan and giving it to shareholders. They have had higher returns than they expected and are thus contributing less now. This means that it costs them less than they thought it would.

Your claim that these are vapor profits is like saying that if they had bought a building for $1 million 10 years ago and were able to sell it for $10 million today that these would be vapor profits. It is true that they don't come from the core business, but as a shareholder it is still cash in your pocket. I care that they didn't come from the core business only in that I will not expect them again in the future or at least not on a regular basis (otherwise the company will have changed to a real estate company).

Point 2) IBM only has to report changes to their actuarial assumptions once a year, in their annual report. Please note that in note V of the 2000 annual report, IBM raised the expected earnings on the pension fund from 9.5% to 10%; I wonder if this is a realistic assumption, or if the change was needed to achieve the desired amount of vapor profit.

I addressed this in my previous post, but I will do so again here. Your first sentence does not mean anything. ALL companies have to report their actuarial assumptions once a year. IBM is not special.

As to whether or not 9.5% or 10% is realistic, it seems pretty simple to me. Let's say that it is too low. The result is that they will end up with more money in the retirement fund than they need (hmmm...interesting that the current state is that they have more than they need). On the other hand, if they assume a number that is too high, they will have a retirement fund that will run out of money...at which time they will have to increase the funding to keep it solvent.

Are you concerned that IBM will not have the money to keep the retirement fund solvent? I could see that this might be a problem if you thought that IBM was going out of business or was going to have some other problem. Please enlighten us as to what you think that is, it would help us make better investment decisions.

On the other hand, in previous posts you have talked about how you think that changing to a cash-balance plan is a bad idea. This is a little ironic. In a cash-balance plan, IBM doesn't contribute based on what they are guessing or assuming the plan will need. They contribute based on what it actually needs. So, if you are opposed to them making an assumption about what they contribute, you should be in favor of a cash-balance plan.

Point 3) The company realized cost and expense reductions of approximately $339 million and approximately $255 million due to the funded status of its pension plans for the quarter ended March 31, 2001 and 2000, respectively.

First-quarter 2001 net income was $1.75 billion, a 15.2 percent increase from the year-earlier period.

This means that in the first quarter of 2001, 19.3% of IBM's earnings were vapor profits from the pension fund, and increase from 16.7% in the first quarter of 2000.


To help anyone who was trying to figure out where you came up with the 16.7%, the First-quarter 2000 net income was $1.52 Billion.

However, I don't think that this is the correct math. The part of the equation that I think you should be looking at is Revenue and Cost, because the savings that they realized was in their Costs. Otherwise, I think you are looking at apples and oranges (pre-tax, post-tax, different tax rates in different years, etc).

2001 Revenue: $21,044 M
2001 Cost: $13,436 M

2000 Revenue: $19,348 M
2000 Cost: $12,414 M

So, in 2001 revenue increased by (21/19.3)= 8.77%
Costs increased by (13.4/12.4) = 8.23%

If they had not been able to realize the costs savings in 2000 (of $255 Million) and in 2001 ( of $339 Million), these numbers would have been

2001 Cost: $13,775 M
2000 Cost: $12,669 M

Increase of 8.73%

So, you could contend that from 2000 to 2001 the additional impact of the savings was that costs increased only 8.23%, rather than 8.73% that they would have gone up otherwise. I'm not an accountant and wouldn't want to try to figure out the impact after taxes.

I am sorry that you are not happy with IBM and the changes to the pension plan. However, I don't think that the accounting practices that they use are questionable. IBM pays good money to an accounting firm to make sure that everything is done correctly.

justpatrick
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