third-quarter earnings report after the close Monday, the big question is whether the technology giant can meet Wall Street's expectations for new services bookings.
Though most analysts are looking for bookings in the range of $11 billion for the quarter, an Oct. 12 note from Goldman Sachs raised the unsettling prospect that IBM might see bookings fall below $10 billion, something Goldman sees as a litmus test for demand. Bookings account for roughly half of Big Blue's revenue.
Bookings below the $10 billion mark would "raise questions about overall IT spending and IBM's own services growth going forward," Goldman analyst Laura Conigliaro wrote in a note. She added, though, that her concern was based on unspecified "checks that we are not able to fully verify." (Goldman has done recent investment banking for IBM.)
A shortfall wouldn't come as a tremendous shock because IBM's customers have been showing a preference for smaller, shorter-term deals for many quarters now. But it would likely weigh on shares.
"While there's no doubt IBM remains the services industry's 'gold standard,' we can't help but think stronger bookings would appear necessary for the type of meaningful services growth many investors seem to expect," noted Fulcrum Global analyst Robert Cihra.
Indeed, global spending on information technology services grew a mere 6.4% last year, according to finalized figures from research company Gartner released on Oct. 6. IBM's sales growth was about in line with the market -- respectable, but hardly the sort of growth rate to get investors all revved up.
Helping matters somewhat, IBM's services operating margin is expected to show improvement in the third quarter -- a comforting sign for investors concerned by relatively slow growth and ongoing price pressure in the services industry. Fulcrum estimates that after 70 basis points of improvement in the second quarter, IBM's pretax services margin will improve by a similar amount in both the third and fourth quarters.
In fact, Fulcrum analyst Robert Cihra calls services profit margin the single biggest swing factor for IBM, estimating that each 100 basis points of improvement in its services margin equates to a hefty 20-cent gain in annual earnings per share. (Fulcrum doesn't do banking with IBM.)
Meanwhile, services bookings aside, most analysts think Big Blue's results will be good enough to meet the consensus estimate for September-quarter earnings of $1.14 a share on $23.4 billion in revenue.
IBM watchers expect to see a payoff in results of its hardware business, which accounts for about a third of revenue, helped by share gains at the expense of
. IBM's mainframe business should post year-over-year gains for the fifth quarter in a row, although some of those observers speculate that its current product cycle has mostly peaked.
IBM's somewhat volatile semiconductor arm, often tagged as a swing factor in earnings, is expected to stay in the black, helped by improving yields and output.
Finally, the company has said its revenue growth will be aided by about 4 to 5 percentage points of currency benefit.
All told, strength in hardware, chips and currency should help offset expected weakness in IBM's software line, which kicks in 16% of total sales. "Closure rates
on software deals remain slow as the shift by customers to 'as needed' spending and the need for higher levels of approval for even relatively small deals continues," wrote Conigliaro.
For now, Wall Street sees relatively little reason to get excited about IBM shares. Though the stock has fallen 15% from its high in February, based on Friday's close of $84.85, it doesn't stand out as a bargain.
Big Blue trades at 17 times the 2004 consensus earnings estimate, putting it about on par with the
. That's about in line with IBM's historical range of 0.8 times to 1.1 times the broader market.
The enterprise spending pickup that was widely anticipated earlier this year hasn't really materialized. Though
IBM's hardware share gains deserve credit, the relatively sleepy growth backdrop combined with price pressures in its core services business will likely curb investor enthusiasm for Big Blue.