Updated from 7:31 a.m. EDTAs IBM's ( IBM) stock regains some momentum, it's the momentum of the company's global services unit that's on investors' minds heading into Monday's third-quarter earnings report. On the heels of a
Wagle believes that the company is more likely to surpass sales estimates than earnings, but some buy-side analysts suggest that earnings are more likely to surprise. Investors may be anticipating the same thing: after a two-month backslide, IBM shares have run up about 8% over the past three weeks. The layoffs also should help improve margins for global services. Gorman says he will look for some margin improvement in the third quarter. But the cuts should allow IBM to show even more margin improvement in the fourth quarter and 2006, other analysts say. Growth in global services has become crucial to IBM's story because the unit now generates more than half of the company's total sales. However, despite IBM's evolution into a services company, investors still will be watching two pieces of the company's hardware business -- mainframes and microelectronics -- because they're both on the cusp of new product cycles. IBM began shipping its
new z9 mainframe line in the last two weeks of the quarter, which Gorman believes is not enough time to materially boost IBM's third-quarter results. But mainframe sales should really kick in during the fourth quarter and result in higher growth in MIPs -- million instructions per second. The amount that IBM charges for mainframe software is determined in part by MIPs (higher MIPs equal higher software charges). Moreover, mainframe computer sales often lead to additional sales in software and services. "We look for a decent mainframe cycle here," Gorman says. Meanwhile, IBM's microelectronics business should start benefiting from sales of video-game microprocessors for Microsoft's ( MSFT) upcoming Xbox 360 release after Thanksgiving, Sony's ( SNE) PlayStation 3 expected next spring and Nintendo's Revolution launching by the end of 2006. Bernstein analyst Toni Sacconaghi, who rates IBM an outperform, estimates that the company could ship 2 million to 3.5 million game processors in 2005, which translates into revenue of $240 million to $400 million at $120 per processor.
Overall, that's a small portion of the $91.4 billion in total sales he's projecting for IBM in 2005. But the microelectonics division can have a larger effect on operating income because it's so capital-intensive. Software, on the other hand, involves very little capital and is a higher-margin business. The third quarter, however, is typically soft for this unit, prompting Wagle to project flat software sales. The fourth quarter, on the other hand, is typically strong in software and should be even stronger this year because of the mainframe cycle, he adds. And because the fourth quarter is IBM's biggest quarter of the year overall, investors will be keenly interested in the company's outlook for the period. Analysts are expecting IBM to earn $1.87 a share on $25.65 billion in sales, representing robust sequential sales of growth of 18% and even larger earnings growth of 65%. If IBM can deliver such strong results in the fourth quarter, investors should finally be satisfied that a sustainable recovery is under way.