Services Soothe IBM

Cautious optimism abounds as the company's largest segment rebounds.
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IBM's

(IBM) - Get Report

improvement in services bookings and operations had analysts in a cautiously optimistic mood on Wednesday.

Yet despite some positive commentary, the stock dropped a bit in Wednesday trading, falling 99 cents, or 1.2%, to $82.37. Shares had risen about 2% amid the broad market surge on Tuesday.

IBM posted its

first-quarter earnings on Tuesday after the bell, soundly beating the Street's earnings forecast and delivering revenue in line with projections. Big Blue's net income rose 22% to $1.7 billion, or $1.08 a share, up from $1.4 billion, or 84 cents a share, a year earlier. Revenue fell 10% to $20.7 billion, but was up 4% when adjusted for currency and the company's divested PC business.

Analysts polled by Thomson First Call expected the company to earn $1.05 a share on revenue of $20.72 billion.

"We were modestly encouraged by the results," said Bill Gorman, vice president of equity research at PNC Advisors. There had been indications that "the services segment was finally showing a steady recovery and that came out in the numbers as well."

IBM global services, which accounts for more than half of the company's revenue, declined 1% as reported but improved 3% at constant currency when compared with the same quarter last year. The segment brought in $11.6 billion.

Global services' gross profit margin rose 2.3 points from the first quarter of 2005.

Bernstein Research analyst Rod Bourgeois attributed the improvement in global services to the impact of improved overall signings in 2005, restructuring, and a healthier consulting/systems integration market.

Given these trends, "IBM global services could be positioned to achieve mid-single-digit revenue growth in the second half of this year, representing a clear rebound for the industry's largest player, buoyed by solid cyclical demand trends, general customer needs for access to talent, and improved IBM execution," Bourgeois wrote in a research note on Wednesday. Bernstein does not have an investment banking relationship with IBM.

PNC's Gorman also was pleased with the company's growth in software, especially the company's middleware segment, which was up 11% year over year, 14% when adjusted for currency. He also noted positive news in microelectronics, which grew 37% in revenue from the year-ago quarter.

But Gorman was surprised by the weakness in the higher-end server groups like mainframes, the system i servers and the Unix-based group, which competes with

Hewlett-Packard

(HPQ) - Get Report

and

Sun Microsystems

(SUNW) - Get Report

. However, he believes there is momentum for the rest of the year as new product cycles are completed. PNC holds Big Blue shares.

Moors & Cabot analyst Cindy Shaw called the quarterly report a "nice earnings improvement ... and ample opportunity for more" in a Wednesday note. Shaw doesn't own shares of IBM, but her firm has banking ties to the company.

"Strong services bookings bode well for revenue growth, in our view," wrote Shaw. She has a buy rating on the stock. "Another $500 million in restructuring savings should be realized in the second and third quarter, a positive for the margin outlook. We think a richer hardware mix could drive upside to our second half of 2006 forecast."

Shaw, and analysts with Bear Stearns and Edwards all raised their earnings targets for the company after Tuesday's results.