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IBM Poised to Please

The stock has moved higher as investors bet that real growth is returning.

A renewed faith in tech stocks has helped propel IBM (IBM) - Get International Business Machines (IBM) Report shares this fall, with some believing a turnaround is nigh for the company's critical but beleaguered services business.

IBM, which reports third-quarter earnings after the bell Tuesday, has been an eager participant in the late-summer rally, with shares surging more than 14% since it

delivered its second-quarter results. On Monday, the stock added 63 cents to $86.71 on heavier-than-normal volume.

"I think it's a matter of investors finally showing some interest

in IBM because it had been lagging," says Bill Gorman, a vice president with the equity research staff at PNC Wealth Management, which holds IBM shares. The stock "hadn't done all that much" until this fall.

"Tech has actually done a lot better since

IBM reported in mid-July," says Standard & Poor's analyst Richard Stice.

Indeed, the mood ahead of Big Blue's last report was, well, blue: "The level of expectation on Wall Street was so low, in my mind, there was only one way to go afterward, and that was up," Bob Djurdjevic, president of Annex Research, who owns shares, observed just after IBM reported its second-quarter earnings, beating estimates by a penny.

For IBM's third quarter, Wall Street analysts are looking for EPS of $1.35 on sales of $22.08 billion. Analysts expect the company to meet those targets, with potential earnings upside.

As is the usual, IBM observers are keeping their eyes trained on the company's services business, which represents more than half of its revenue. Analysts see signings ranging from $10 billion to $11 billion.

"We'll have to see what they say about orders in the services business," PNC's Gorman says. "In the past, that's been somewhat inconsistent."

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"I think the biggest area in terms of revenue drivers is going to be on services -- and if they are able to get that turned around," Stice agrees. When the company last reported, contract and sales cycles had elongated in that last month of the second quarter, he says, accounting for some of the lack of revenue growth.

Toni Sacconaghi, who covers IBM for Bernstein Research, wrote that he expects services to stabilize after an uninspiring second quarter. "Publicly announced signings of $1.7 billion were notably better than Q2's $440 million," he wrote.

Beyond near-term stabilizing, however, some watchers see an eventual return to real growth in the company's critical services sector.

Bookings in the fourth quarter should improve "given benefits from push-outs of major deals and easier sequential compares," wrote UBS analyst Benjamin Reitzes in a recent note. However, short-term signings are still "an area of concern."

"IBM usually has a big fourth quarter, like most of these computer companies, so perhaps they are setting themselves up for a decent finish to the year," Gorman adds.

Still, while IBM isn't the kind of stock most investors buy for a one- or two-quarter run, the company's longer-term picture also seems to be brightening.

"While data points from 3Q and 4Q are important, the key theme underlying our investment thesis is that fundamentals within IBM's services unit ... are bottoming and growth should reaccelerate over the next 12 months," Thomas Weisel analyst David Grossman wrote in a recent note. His firm does and seeks to do business with the companies it covers.

He says that restructuring has paid off, and global services' pretax margins have consistently improved since the fourth quarter of 2005. Still, reacceleration in bookings and sales growth hasn't been as speedy as he would like.

In IBM's hardware and software divisions, Citigroup analyst Richard Gardner sees third-quarter upside in both areas based on strong IT spending and product cycles for several of IBM's servers. His firm does and seeks to do business with the companies it covers.

UBS analyst Benjamin Reitzes says that the company has resolved some of the hardware gaffes from the last quarter. It is now shipping its high-end System P servers and has fixed its

Restriction on Hazardous Substances issues with its System X line. In the second quarter, System P servers sales fell 10%, System I revenue declined 7% and System X was flat.

"Software seems to be executing well while also benefiting from acquisitions," Reitzes wrote. His firm has an investment banking relationship with IBM.