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IBM Finds Its Groove

The stock hits a 52-week high as Wall Street cheers.
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Investors and analysts applauded

IBM's

(IBM) - Get International Business Machines (IBM) Report

impressive third-quarter results on Wednesday, with many seeing room for more upside ahead.

Analysts pumped up their estimates, and shares tacked on 4.7% in recent trading, pushing the stock to $91.05 on more than triple the usual volume. Earlier in the session, the stock hit a 52-week intraday high of $92.04.

"We're pretty pleased with their performance, especially with respect to their shorter-term signings in services," says Kim Caughey, an investment analyst with Fort Pitt Capital Group, which holds IBM shares. "We believe this is going to lead to longer-term signings in the next year, as well as increased sales in hardware and software."

Caughey says those short-term signings "prime the pump for the sales engine" to upsell customers to longer-term consulting services and technology.

Such encouraging numbers in short-term deals have been "missing in the last couple of earnings calls," she says.

For its third quarter, the IT hardware and services giant earned $2.2 billion, or $1.45 a share, soaring past the $1.35 a share Wall Street had anticipated.

On the top line, IBM reported $22.62 billion in revenue compared to $21.53 billion in the same period last year, and above the consensus target of $22.08 billion.

IBM's gross margins rose to 42% from 40.6% in the year ago quarter.

"While we can't expect results like this every quarter, IBM reported strong revenue/EPS upside from strength in hardware/software along with margin improvement," Bear Stearns analyst Andrew Neff wrote.

Neff noted that the company is still selling at a 20% discount to its rivals, and it "deserves more credit for consistency and modest improvement in sales growth, meriting upside to around $98." Bear Stearns has a non-investment banking relationship with IBM.

Neff upped his full-year 2006 estimates from $5.85 a share to $6 a share on revenue of $91.1 billion, up from $90.3 billion.

The stellar performance in the company's software division, in particular, seemed to signal more good times ahead.

Software sales totaled $4.4 billion, rising 9%, or 7% adjusted for currency, compared to the same period last year. IBM's middleware brands grew 12% compared with the same period last year. WebSphere, Tivoli and Information Management all saw double-digit growth.

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And IBM is keen on beefing up the segment even more. The company has made nine acquisitions in software this year, including

Webify

,

MRO

and

FileNet

.

Goldman Sachs analyst Laura Conigliaro noted that while the latest software deals are unlikely to add to the bottom line until late next year, "IBM's ability to integrate and deploy software assets, as it has already successfully done with numerous tiny software acquisitions, should accelerate the growth in the newly acquired businesses and make them meaningful contributors to earnings by 2008."

She expects software will shift to a larger chunk of the company's revenue, from 19% in 2004 to 21% by 2007.

Conigliaro raised her price target from $92 to $100, and noted that "we think the stock still has room." Goldman has a banking relationship with IBM.

Analysts were also pleased with the company's hardware performance, which grew 9%, or 8% when adjusted for currency, to $5.6 billion compared with $5.1 billion a year ago.

Sales of the System Z series wowed, up 22% at constant currency. System P grew 8% when adjusted for currency. Meanwhile, microelectronics was up 29%, and storage grew 11% at constant currency.

In services, long-term signings dropped, but improved short-term signings buoyed investors' mood.

"Given that short-term signings have a larger near-term impact on both revenue and profitability, we view this as a positive leading indicator," wrote Bernstein Research's Toni Sacconaghi. "We also note that Q4 could prove to be a strong quarter for total signings: IBM won a portion of the

Vodafone

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outsourcing deal, which we believe could be

a $1 billion to $2.5 billion deal for IBM and will very likely close in Q4."

He also noted a pending $2 billion deal with the German army and two other large deals that could total $1 billion together that slipped into the fourth quarter.

IBM's Mark Loughridge said on the earnings call that some deals failed to close in time to be included in the third quarter.

Bernstein's Sacconaghi, who has an outperform rating on the stock, also boosted his target price to $100 from $95, believing earnings will continue to best consensus throughout 2007. He also noted that the company is typically at its best in the fourth quarter. Bernstein or one of its affiliates own IBM shares.

"We are encouraged that Q4 could be a solid one for IBM -- particularly for revenue growth and signings -- which have historically been important catalysts for the stock," Sacconaghi wrote Wednesday.