Shares of IBM ( IBM) slumped on Friday after an earnings report that beat the Street wasn't enough to sustain investor enthusiasm in another tech stock that has enjoyed a big runup. Big Blue shares shed $3.50, or 3.5%, to $95.95 in recent trading. "We saw what happened with Apple ( AAPL) earlier in the week," says Bill Gorman, an equity research analyst with PNC Wealth Management, which holds IBM shares. "The tech tape has turned negative for the time being.
The tech sector in general is down almost every year from the February to May timeframe." But Gorman says he thinks the reaction is misplaced. "Software and services are clearly the drivers in this company now -- there were some positives there." It's perhaps not a huge surprise that investors are using the opportunity to take profits. Before IBM posted its results, its shares had charged up more than 16%, topping $100, since it last reported quarterly earnings. The market reaction could be a chance to get in on shares, wrote Bernstein analyst Toni Sacconaghi: "We ...would encourage investors to add to positions, particularly on any notable pullbacks." "The stock's selloff in the after-market Thursday likely appears attributable to worries about the sustainability of margins going forward, which we think are overblown, given that margin pressure appears attributable to investments, rather than destructive market or competitive dynamics," he wrote. He has a buy rating on the stock, and his firm exercises investment discretion on more than 1% of outstanding common stock of IBM.
For the quarter, IBM earned $3.54 billion, or $2.31 a share, vs. $3.19 billion, or $1.99 a share, in the same quarter 2005. On a continuing operations basis, the company made $2.26 a share, including a 6-cent-a-share tax benefit. Without the benefit, IBM earned $2.20 a share, besting Thomson Financial analyst estimates by a penny. Revenue totaled $26.3 billion, compared with $24.4 billion for the fourth quarter a year ago. Analysts polled by Thomson Financial had forecast $25.66 billion. "I was impressed with the revenue," says Sushi Wagle, senior vice president of investments at J&W Seligman, which does not currently own shares but has in the past. "The bookings on the services front were very solid. Where the results got a little mixed was on the hardware side." He'd look for an entry point in the shares between $88 and $92, where shares would trade at around 13.5 times 2007 earnings, give or take a few points. "All in all, I think it was a very solid quarter," Wagle says. "Apple had a solid quarter, too, but people sold it like crazy." IBM CFO Mark Loughridge said late Thursday that software sales grew at its fastest clip in five years to $5.65 billion, rising 14%, or 11% at constant currency, from the year-ago quarter.
Software also was the largest contributor to profit, at about 40% of segment pretax profit, he said. WebSphere, Tivoli and Lotus, along with other "key-branded" middleware, continued their stellar performance, growing 25% (21% at constant currency). IBM global services, which brings in the bulk of revenue, "were strong on all metrics -- total signings were $17.8 billion, short-term signings were very strong at $6.2 billion with pricing up, and backlog erosion was zero, similar to last quarter, and IBM's best showing in 20 quarters," wrote Bernstein's Sacconaghi. "We believe the strength in signings -- particularly short-term signings and IBM's outlook -- bodes well for services revenue growth in 2007," he added. Canaccord Adams analyst Peter Misek, who has a hold on shares, also noted that services bookings "were far better than we had anticipated, and combined with a strong pipeline of opportunities entering fiscal year 2007, we believe the global services division could perform well in the latter half of 2007." His firm does not have a banking relationship with IBM. Short-term signings can typically lead to longer-term signings and generate other business for IBM in software and hardware. For the quarter, hardware revenue was somewhat disappointing, PNC's Gorman says, but "not a total surprise." System I server sales fell 10% year-over-year, or 14% at constant currency.
"That's been weak for so long. It's a mature product group," Gorman says. "When it happens once, it happens once. But when it happens every three out of four quarters, this is not a growth business." Despite the market reaction, he was satisfied with IBM's overall performance. "This is a $91 billion
in revenue company. There will be a lot of hits and some misses every quarter," Gorman says.