Skip to main content

Updated from 8:19 p.m. EDT Monday:

With more than $80 billion of revenue spread among business lines as diverse as mainframes,


servers, PCs, enterprise software and consulting,



is one of the most difficult companies any analyst has to follow. Consequently, it's one of the biggest wild cards the market has to deal with during earnings season.

Up and Down
Big Blue sharply off recent highs

Investors draw that card Tuesday, when the company reports its third-quarter earnings after the close. Tuesday morning, the stock was up $1.25 to $112.38.

The difficulty of covering IBM may be one reason for the relative dearth of analysts' notes on the company in the last month, a period that has seen the company's stock lose 10% amidst sales and/or profit warnings from a growing group of technology companies. That vacuum of commentary has been unsettling IBM investors, who've been hearing earnings-shortfall rumors circulate to the point of approaching conventional wisdom in recent weeks.

There's certainly no shortage of reasons why IBM could disappoint. You can start with the euro, the faltering currency that



last month blamed for its slowing sales. Like many large tech outfits, Big Blue gets a significant percentage of its revenue from Europe, and that fact led

Goldman Sachs


Laura Conigliaro last month to

slash her sales and earnings estimates through the end of 2000. (Goldman hasn't done recent underwriting for IBM.)

Red Flag

A more serious red flag is IBM's heavy reliance on the corporate market, where capital spending is starting to show signs of slowing, as evidenced by warnings from



and mainframe-software maker

BMC Software



"They are an $80 billion behemoth," says Fred Hickey, who has correctly predicted the problems at Dell and Intel in the pages of his

High Tech Strategist

newsletter. "If there is truly a capital spending slowdown going on, then how could IBM be immune? People believe that



has had trouble, but not IBM?

CEO Lou Gerstner has a magic bag full of tricks that seems bottomless, and so far it has been. Those rabbits keep coming out of his hat." (Hickey owns put options on IBM, and thus stands to profit if the stock declines in price.)

The market was braced for a thoroughly mediocre second quarter from IBM in July. But Gerstner's magic bag yielded an upside surprise of 6 cents a share. And despite the obvious obstacles, there are a number of factors working in IBM's favor this time around.

A.G. Edwards

analyst Shebly Seyrafi, for one, expects IBM to continue to build on the strong growth it saw in Unix servers in the second quarter. In addition, weak year-over-year comparisons, courtesy of the Y2K slowdown in corporate spending, should help the mainframe business post at least decent-looking growth. (A.G. Edwards hasn't done underwriting for IBM.)

But the company's brightest prospects may lie in its services business. In the second quarter, IBM surprised investors by reporting $20 billion worth of new bookings for services, nearly double what most analysts were expecting. That created a backlog of about $7 billion, which could go a long way toward making up for any problems in the third quarter. And investors listening in on IBM's earnings

conference call will be anxious to see whether that huge jump in booking was a one-quarter phenomenon or something more sustainable.

The Key

It's difficult to overstate the importance of services for IBM's future. Here's why: The company's overall hardware business has been marked by declining profit margins and stagnant growth at best. The software segment sports whopping gross profit margins, but sales there have been declining for years. Only services has been marked by both strong growth and thickening margins. But even that growth has been starting to slow over the last couple years, the second-quarter jump notwithstanding.

In July, Gerstner told analysts that he expected IBM to maintain long-term revenue growth in the high single digits, and double-digit earnings growth. And any lowering of those numbers Tuesday will likely prompt some drastic revaluations. The market rarely moves with a slow hand when it rethinks its assessment of large-cap growth stocks. And lately, Wall Street has been more unforgiving than it's been in years in its treatment of poor results.

"The assumption is that because for some period he's been able to pull it off, he'll blow the numbers out and save Wall Street," Hickey says. "I can say he better damn well do it. If he doesn't, they're going to kill that thing, because no one wants to be in IBM's fundamental business. If they're worried about being in Intel's or Microsoft's, what about IBM's?"

Analysts polled by

First Call/Thomson Financial

expect IBM to earn $1.08 a share, up from the year earlier's 90 cents, while sales are expected to come in between $21 billion and $23 billion.