Banking & Capital Markets

IBM Warning May Ripple Everyone’s Lake

International Business Machines says businesses aren't buying so many machines. Also: Auditors offer up changes to boost the capital markets, and w...
John GoffApril 8, 2002

These days, making predictions is a risky pursuit.

Take the equity markets, for example. A whole host of analysts have been predicting that improved first quarter corporate earnings would help boost share prices on the major stock exchanges. Improved earnings, they said, would set the stage for a resurgence in the struggling IPO market.

So much for that theory. This week, a Q1 earnings warning from IBM, of all people, practically capsized the Dow Jones Industrial Average. While the market eventually rallied, the announcement initially knocked the DJIA down by nearly 100 points.

The reason for the earnings warning? Management at IBM reported that the company saw a huge drop-off in its technology group, due to decreased IT spending by corporate customers. IBM management says the tech group’s revenues will fall about 35 percent, or eight cents per share. All told, IBM expects first-quarter revenue to come in around $18.5 billion, down from the $21 billion in business the company did during the same period a year ago. The drop-off means IBM will report first quarter earnings per share of about 68 cents. By comparison, the company generated per-share earnings of 98 cents during the first quarter of 2001.

The IBM warning came as a real big surprise to Wall Street. Although the company’s accounting practices have been the subject of much scrutiny of late, few analysts were predicting a big decrease in earnings for Big Blue. In fact, according to Thomson Financial/First Call, most analysts had IBM posting first-quarter earnings of about 85 cents per share.

The IBM announcement was the first earnings warning for the Armonk, N.Y.-based company since June 1991.

Q1 IPO Report Card: C+

The IBM warning isn’t going to help the market for initial public offerings.

That market could use some help right about now. In the first quarter of 2002, 15 companies went public. All told, the new market entrants raised a total of $9 billion, according to IPO.com. By comparison, 17 companies went public in Q1 2000, raising around $7 billion.

Going by that comparison, the IPO market wasn’t exactly dormant during the first quarter of the year. But bear in mind, in the previous stanza (Q4 2001), 27 companies launched IPOs, raising over $10 billion. And Q1 2001 didn’t feature any mega deals like the $3.9 billion offering from Travelers Property Casualty. The Travelers’ underwriting, the fifth largest initial public offering in U.S. capital markets history, launched in late March — and helped substantially bump up the IPO numbers for the first quarter of the year.

While a host of companies have filed to go public over the next few months, the IBM earning warning could keep many potential issuers on the sidelines. An oil embargo by Iraq and Venezuela won’t help, either. This week, for example, low-cost passenger airline JetBlue is slated to go public. Several other regional airlines are also expected to launch IPOs in the coming months, including ExpressJet (the Continental Airlines spin-off), Republic Airways, and Pinnacle Airlines. If the oil embargo triggers a rise in jet fuel costs, however, those offerings may be put on stand-by.

Internal Auditors: We Want Changes

Apparently, the Institute of Internal Auditors (IIA) would like to see some changes made to corporate governance, risk management, and control processes.

Appearing before a special committee of the New York Stock Exchange on April 4, IIA President William Bishop III offered up three recommendations to strengthen corporate governance. These suggestions, he believes, will go a long way in restoring public confidence in capital markets.

Specifically, Bishop thinks the three major U.S. stock exchanges should jointly issue a uniform set of corporate governance principles for publicly held companies. Under that plan, the board of directors of a public company would be required to disclose in its annual reports the extent to which the company is in compliance with those principles.

Bishop says that promulgating a strong corporate governance code and requiring board reporting on the extent of compliance would be of substantial value to corporate stakeholders. By his lights, a standard governance would provide “a benchmark against which the public could reliably gauge the fulfillment of fiduciary duties by all parties in the governance process.”

The IIA would also like to see boards of directors of publicly disclose an assessment of the effectiveness of internal controls within their organizations. Such disclosures would address internal controls broadly, and not just accounting controls over financial information recording and reporting.

In his appearance at the NYSE, Bishop argued that any company that accepts investor dollars should maintain a comprehensive internal control system that is monitored for effectiveness on an ongoing basis. He believes corporate managers should be required to provide detailed mandatory reporting on a company’s ethical environment, the identification of risk, and broad operational controls (including integrity and reliability of financial information, safeguarding of assets, efficiency and effectiveness of operations, and compliance with legislation, regulations, and policies).

Further, the IIA wants publicly held companies to establish and maintain an independent and competently staffed internal audit function. That staff would provide management and the audit committee with ongoing assessments of a company’s risk management processes and the accompanying systems of internal control.

If an internal audit function is not present, Bishop thinks the board of directors should be required to disclose in the company’s annual report why the function is not in place. Bishop also noted that he believes a company’s internal auditor should functionally report to the audit committee of the board, but administratively report to the CEO.