IBM: Century Bond Exchange Analysis

International Business Machines Corp. (IBM) Announces Debt Exchange

On May 21, 2012 IBM announced an offer to exchange all of its December 2096 bonds held by investors and institutions.

I just spoke to an IBM Manager in Global Funding and Investments, Mr. Easwaran K. Venkatasubramanian who explained that the offering is "not compulsory." The December 2096 IBM 7.125% coupon bonds (CUSIP No. 459200 AP 6) are currently valued at between $116 - $127, and are for sale on the secondary market for $145.492.

So if you buy them currently you will immediately lose between $200 and $300 per bond in value. However if you tender them you will get $1,396 in new 4% IBM 2042 bonds and $200 in cash. IBM calls the 4% June 20, 2042 bonds, "the new notes," and does not yet list a CUSIP.

The early exchange date for this offering was June 4, 2012. However because the original announcement was made recently some brokerages have not had the information vetted through Depository Trust Company, DTC. The final cut off for an exchange is listed by IBM as midnight June 18, 2012.

In addition to the December 2096 bonds, IBM is offering to exchange all of its 8%, October 2038 bonds (CUSIP No. 459200 GL 9) and "up to $800,000,000 aggregate principal amount of its 5.600 percent notes due 2039 (CUSIP No. 459200 GS 4)."

Additional Considerations

IBM's treasury department said, that supposedly IBM will give an odd lot of bonds (such as "1,400" notes,) in exchange for the old bonds. However this information should be confirmed with your brokerage. (I have not often or ever heard of bonds being distributed in increments other than 1,000, however brokers have told me it does happen rarely. Please confirm this or any exchange details with an accredited brokerage.)

Currently yields are very low, so IBM is trying to take this opportunity to reel in debt issues; in exchange for lower yielding securities. This could benefit holders of IBM century bonds who want to reduce holdings for nearer term bonds and cash. IBM said that owners of the bonds can tender just a few of their total bonds.

Holders of the 8% 2038 bonds have a 100% greater coupon on their holdings, than the new 4% notes. Depending on their purchase price these bonds likely have greater than 4% yield. This is why IBM is offering $1,654 in new notes, with no additional cash offering. As an investor you need to realize that if interest rates go up, and corporate bond rates go up a 4% 2042 bond may not be as attractive and the price can go down.

Another article; "Conditional Full Redemption of CorTS Trust V for IBM Debtures Class A CUSIP 12618Y203" describes a separate security that holds $41M worth of the 2096 IBM bonds. The CorTS Trust V is structured and managed differently, and they use "Callable Trust Certificates," within the trust other than their 2096 IBM bond position.

So if you are an owner of the individual bonds, which are listed as not callable (though there may be some conditions please consult your broker) you have the option to keep the bonds. If you are an owner of the Class A or Class B (CUSIP 12618YAA2) CorTS Trust V, then the action will be dependent on the actions of the trustee, U.S. Bank Trust National Association.

The CorTS Trust V articles state:

"Further, with respect to IBM's exchange offer announced May 21, 2012 related to their 7.125% Debentures due December 1, 2096, the Underlying Securities for the CorTS Callable Trust Certificates, CorTS Trust V for IBM Debentures, the Warrantholder has notified the Trustee that it does not consent to the exchange."

IBM's Credit Rating

One of the reasons behind IBM's offer may be that Moody's (MCO) raised IBM's credit rating to Aa3 in November 2010. In August 1995 IBM's credit rating was upgraded from A1 to A3 (upper medium grade.)

It is important to note that IBM's only two rating action movements (other than confirmations) by Moody's in the past 20 years have been these upgrades. The most recent move to Aa3 places IBM in the high grade credit rating.

So now the company can borrow money at a lower rate, for now.

Century Bonds

These types of bonds can be very risky. However if you find an institution that you believe has what it takes. considering some of the long term debt can be novel. Currently the yield on the IBM 2096 bonds is about 4.88%.

There are a few AAA rated century bonds out there too. However you have to examine all of the factors that could contribute to a worst case scenario and loss of capital.

Additionally keep your eye out for caveats and restrictions, like certain companies who issue very long term bonds with calls based on new tax codes. This is the case with the Coca Cola Enterprises (CCE) century bonds. Disney (DIS) also has century bonds however they are callable each year for less and less; so the company has the option to buy them back nearly at par well before the maturity date.

After speaking to IBM it seems that holders of the 2096 and 2038 bonds are able to just hold their securities; or tender them if they want. Investors should also account for the fact that these fixed income products generate taxable income if held in a non IRA. It is very important to check with a tax advisor to figure out tax implications of this exchange. For this reason I recommend considering an investment in such a bond in your IRA.

If you have any additional considerations, or want to discuss the impending tender offer below, please leave a comment. For any more specifics please consult your brokerage or IBM's treasury.

Disclosure: I am long IBM, DIS, MCO.