The decision by Moody’s Investors Service Inc to take an axe to its ratings on IBM Corp’s debt on Friday (CI No 2,238) shows the downside of Louis Gerstner’s decision to take a kitchen sink set of write-offs against second quarter figures to leave the company with a clean sheet, able to embark on a fresh start. Gerstner had hoped to get all the additional job cuts out of the way so as to be able to begin the process of rebuilding shattered morale – but with the news that job cuts at IBM Deutschland GmbH will continue into 1995 (see front), it becomes clear that while a clean slate may be possible in the US by the end of this year, it certainly will not be in some of the major foreign subsidiaries – and the cultural environment in which IBM Japan Ltd operates suggests that downsizing there will be protracted and painful – and morale-sapping – too. Moody’s latest downgrades leaves IBM with a mere figleaf of respectability: any further cut would dump it unceremoniously into the B ratings – indeed Moody’s cuts included a Baa-1 rating for IBM’s new issue of preferred stock, down from single-A-3. Below Baa, a company’s debt is no longer regarded as investment grade, and attracts the unwelcome epithet junk bond: the aspect that is important is that a large number of fund managers and trustees are precluded from investing in anything outside the investment grade category, which means that not only does a company have to pay a significantly higher rate of interest – in itself damaging to the business, but the range of investors it can tap for cash starts to dwindle. As reported, Moody’s said that the ratings downgrade was based on the outlook for increased business risk as IBM moves its revenue base to lower margin products and services, the heightened operating risk as IBM seeks to align its cost structure with its revenues, and increased financial risk stemming from the cash costs associated with the restructuring actions. The rating action concluded a review initiated on July 27 1993.

Additional restructuring actions

Moody’s warns that IBM’s operating results and debtholder protection measures will be under pressure for the intermediate term as the company seeks to remake itself into a more nimble, customer-focused competitor in the volatile and intensely competitive computer industry. Crucially, Moody’s is not convinced that IBM’s new strategy will work. IBM has targeted growth in non-hardware businesses, such as services, to offset the precipitous declines in its hardware revenues and operating margins, but it is Moody’s opinion that continued growth from non-hardware sources may not be sufficient to offset anticipated further hardware sales declines, it says. IBM has taken over $28,000m in restructuring charges in the last six years in an effort to realign its cost structure and adjust its capacity levels to slowed revenue growth rates and lower operating margins, and its mainline debt has increased considerably. A key concern with many observers is that IBM’s big push into services, particularly facilities management, may maintain volume but will be near profitless, not least because it involves robbing Peter – IBM’s mainframe business, to pay Paul its facilities management. If margin pressures continue, it is Moody’s opinion that additional restructuring actions may be required, and would further reduce IBM’s financial flexibility, it said.