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IBM in Tech-Spend Spotlight

A blowout earnings report would help allay slowdown fears.

SAN FRANCISCO -- Investors will get a better idea of evolving tech spending patterns when



releases its third-quarter earnings after markets close on Tuesday.

Big Blue is a bellwether for the tech industry, given its wide range of servers and data storage hardware, business software and consulting and support services. Updates to the company's future financial targets and comments made by management will shed light on whether IT managers are likely to tighten budgets, as some investors fear.

Investors have become skittish about a possible U.S. economic slowdown that could threaten tech's continued growth. Any hint that sales are at risk can whipsaw tech stocks.

Doubts about future IT spending were in part responsible for last Thursday's nose dive in



stock, which by most accounts should have soared on a

strong second-quarter showing. Analysts and investors said the company couched its conservative full-year guidance in lukewarm tones by saying that it could not foresee how clients' IT budgets would take shape in January 2008.

Stocks of several large tech companies also careened last Thursday after a JPMorgan analyst said that Chinese Internet commerce site


would meet -- but not exceed -- analysts' third-quarter expectations.

The selloff hit high-fliers like



and BlackBerry maker

Research In Motion



Tech companies have outperformed most other industry sectors so far this year, especially as rapid global growth and a weak dollar fuel sales of computers and other hardware needed to wire emerging economies. IBM's sales from outside the U.S. have steadily grown in recent years and now account for over 54% of total revenue. The company's sales in Russia, China and other emerging markets outpaced all other geographic regions in the previous quarter.

In the second quarter, earnings from tech companies in the

S&P 500

grew 12% from the same period a year earlier, vs. about 8% for the entire index, according to Thomson Financial. Hardware makers led the pack with 38% growth, followed by software and services. The semiconductor subset was the only major tech category in which earnings fell.

Analysts expect tech earnings to grow 9% in the current quarter vs. flat growth for the total earnings of S&P 500 companies.

Sales have remained strong, and haven't yet foreshadowed a slowdown. If U.S. economic growth downshifts, many analysts say tech service providers may be spared because their support is necessary to run computer networks and applications.

But the outlook for hardware and software purchases is less certain since they can be delayed without shutting a company down.

IBM is the largest company to combine all three of these businesses under one roof, making it a proxy for the overall tech spending climate.

Analyze This

Analysts, on average, expect that IBM's third-quarter sales rose 6.4% to $24.1 billion, fueling a 15% jump in earnings per share to $1.67.

Goldman Sachs analyst Laura Conigliaro expects the company to reiterate its full-year earnings growth target of 14% to 15%, which implies earnings of $6.91 to $6.97 a share.

The company has pursued an aggressive acquisition strategy to expand software sales, which carry higher profits than hardware and services. Investors have seen the fruits of this strategy pay off as IBM has rolled out several new business software applications.

"We're seeing the best profitability coming out of IBM in 10 years," said John Gunthorp, portfolio manager at Hester Capital Management. "We're looking for that to continue."

Hester owns about 125,000 IBM shares, and is expecting them to appreciate to around $130 based on future sales and earnings estimates.

Shares of IBM closed Monday up 22 cents to $118.03.

On the hardware side, Gunthorp will be listening during the conference call for comments on how well IBM's new Power 6 servers are selling.

Estimates of service bookings cluster around $11.5 billion.

Overall, Gunthorp would like to see total third-quarter revenue growth in the range of 3% to 4%, excluding acquisitions and currency exchange effects. Organic growth is an important indication of whether the market demand remains strong, or if IBM and its competitions need to "buy sales" through acquisitions because the market is slowing.

Gunthorp also would like IBM to start paying down some of the debt it has piled onto its balance sheet to fund over $12 billion in stock buybacks earlier in the year. In addition to improving profitability through sales of high-margin software, IBM has made buybacks a major plank of its strategy to increase its annual earnings per share to $11 by 2010.

The heavy borrowing has increased IBM's total debt by over 34% to about $35 billion in the first half of the year.