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IBM Steady Amid the Storm

Shares tick higher amid the tech meltdown, thanks to a big earnings beat.
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Updated from 11:24 a.m. EST


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bulls had the upper hand Wednesday as the company's surprisingly strong earnings performance helped offset anxiety about declining services revenue.

The shares were recently up 93 cents, or 1%, to $83.93, bucking the onslaught of tech selling that greeted a far weaker quarter at microprocessor giant


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. The stock is pinned near the center of its 52-week range and, unlike Intel and



, it has made virtually no progress during tech rally of fall and winter.

Tuesday night, IBM said fourth-quarter earnings rose 13% to $3.2 million, or $2.01 a share, including a $267 million charge of $267 million related to a reduction in employee pension benefits. Excluding the charge, IBM earned $2.11 a share, wiping out the consensus earnings estimate of $1.94 a share.

Total revenue was $24.4 billion, down 12% year over year but up 3% when currency fluctuations and results from IBM's now-divested PC business are included. Even so, the currency hit and the need to back out last year's PC revenue were well-known, and analysts likely included these factors in their estimates. Analysts polled by Thomson First Call were looking for revenue of $25.49 billion.

Bookings in the critical services business were $11.5 billion, down from $12.7 billion a year ago. Last month, some analysts believed the company would book only $10 billion in new business, but the quarter picked up steam at the very end. Gross margins for the services unit improved to 27.4% from 24.3% a year earlier.

Revenue for the services unit, however, was off 5% (1% excluding currency effects) to $12 billion, and constituted "the biggest disappointment in the quarter," Goldman Sachs analyst Laura Conigliaro said in a note to clients.

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Still, she chose to view the glass as half-full, saying: "While we're clearly not excited byIBM's inability to put the whole picture together, neither do we feel the urge to walk away with IBM's earnings continuing to move up, its relative multiple at a rounded-up 0.9 times the

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, and two bellwethers just having missed numbers." Goldman Sachs has an investment banking relationship with IBM.

Overall gross margins, now liberated from the money-losing PC business spun off last May, increased to 44.1% in the 2005 fourth quarter, compared with 38.8% in the 2004 period.

"They got rid of a dud so that the profitability of the rest of IBM hardware can now shine. Hardware revenues without the PC business increased 6% or 9% in constant dollars," says longtime Big Blue watcher Bob Djurdjevic of Annex Research.

IBM's huge software business, however, was flat year-over-year at $4.6 billion, including a 3% currency hit.

Although IBM handily beat bottom-line expectations in the quarter, analyst Richard Williams of ICAP (formerly Garban Equities), says the upside surprise actually masks a weakness.

Earnings were boosted in the just-reported quarter by the 10-cent-a-share pension-related charge, and also benefited from 15 cents a share in cost savings derived from cost cuts in the Global Services unit. The same benefit was felt in the previous quarter. "IBM could have chosen to take the Global Services savings and say, lower prices, but they choose to use the money to improve the bottom line. At some point you run out of room to do that," he said during an interview.

IBM does not give detailed guidance on its calls, but it often will comment on some aspects of the First Call consensus. CFO Mark Loughridge suggested that analysts raise their EPS estimates for 2006 by 12 cents to $5.78.

Hours before it released the earnings news, IBM announced that it has signed a 10-year, $1.1 billion contract to provide


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, the specialty apparel retailer, with mainframe, server, network and help-desk support services across its North American stores and corporate locations. Revenue from the deal was not included in December's results.

Loughridge noted that the deal will contribute just $20 million or $30 million per year in profit. The signings contribute much more to margins and revenue over the long term, he said during a call with analysts.

Loughridge said the company's short-term services business was not up to par, but said he expects that performance to improve later in the year.