Shares of IBM ( IBM) continued falling on Wednesday despite a broader rally in tech stocks. The company's chief financial office, Mark Loughridge, was clearly unable to stem investors' disappointment with
weak third-quarter sales of hardware and software. In a conference call, he argued that the weakness stemmed from a hiccup in sales and customers holding off on purchases as they wait for IBM's new servers and make the most of their current computing power. Investors nonetheless took steam out of IBM's stock, which had been sharply appreciating in recent weeks. After gaining more than 1% during the day, the company's shares fell in late trading after it posted third-quarter earnings that were slightly above analysts' average estimate and revenue in line with most forecasts. Shares were recently trading down $2.90, almost 3%, to $116.70, despite a rally in shares of large tech companies . IBM's results contrasted those of Intel ( INTC) and hard disk drive maker Seagate Technology ( STX). Both companies exceeded analysts' earnings estimates by wide margins and saw their shares gain several percentage points. Intel was recently trading up $1.07, or more than 4%, to $26.55, while Seagate shares had gained 51 cents, or almost 2%, to $26.96. "We could have done better," said Loughridge during the conference, referring to software sales. Loughridge said that while IBM booked smaller sales of less than $1 million at a healthy pace, it failed to close several multimillion-dollar deals.
The weak software sales are especially disappointing to investors who expect IBM to dramatically improve its profitability. In general, gross margins on software exceed 80% vs. 30% to 40% for hardware and services. Earlier in the year, Loughridge outlined an ambitious plan to boost annual earnings by more than 80% to $11 a share by 2010. This plan hinges largely on IBM's ability to make software sales account for about half of its total profits. The company has been on an aggressive spending spree to acquire software firms with products that can enhance IBM's Tivoli, Lotus and Rational products. Despite the quarterly hiccup, Loughridge expects software sales to rebound sharply in the current quarter. He reaffirmed IBM's long-term and short-term profit goals and expects earnings per share to increase 14% to 15% for the current fiscal year. The shortfall in hardware and software sales is somewhat consistent with analysts' forecasts. Given the weakness in financial services, which are big consumers of technology, some had said that discretionary spending on IT might dip as companies put off upgrades to their software systems and network equipment. Services, however, should have better staying power since companies rely on network maintenance operations support to "keep the lights on." IBM's quarterly results bore out this view; its services unit was the bright spot. According to Loughridge, the slack was concentrated among financial services firms suffering from the crisis in the mortgage and credit markets.
In the near term, however, analysts still believe tech companies will outperform the market. For the current quarter, Standard & Poor's expects the operating earnings of tech companies to grow by 13% versus a slight dip in earnings for the total market as financial firms take losses related to mortgage-backed securities. "It will be important to see if IBM can continue to improve its profitability in the next quarter," said John Gunthorp, a portfolio manager at Hester Capital Management. Gunthorp is holding onto Hester's IBM shares with an eye toward its 2010 profit goal of $11 a share and its exposure to rapidly growing international markets. Meanwhile, he's watching to see if another buying opportunity presents itself. "If shares fall another $4 to $6, I would be inclined to buy more," he said. Hester is holding shares of other tech companies that stand to benefit from capital spending and growth in overseas markets. In addition to IBM, Hester holds shares of Intel, Seagate, Hewlett-Packard ( HPQ) and Microsoft ( MSFT).