IBM's third-quarter earnings "disappointment" was the biggest story on Wall Street this week but judging from comments made by analysts, investors need to get past the cover and delve into the details before abandoning mainframe software stocks.
Granted, IBM didn't post the spectacular earnings and revenue growth that its investors had come to expect in the past year.
The day after the earnings report hit the Street, the stock fell an alarming 15 percent in extremely heavy trading.
However, it did meet analysts' estimates this quarter, earning $1.8 billion, or 90 cents a share, on sales of $21.1 billion.
It's hard to fathom why the Street would punish the stock as it did considering that it did manage to grow sales by 5 percent sequentially and it did earn $1.8 billion.
Analysts were looking for total sales in the neighborhood of $21.7 billion. It didn't help matters that CEO Lou Gerstner called it a "decidedly mixed" quarter.
Predictably, other mainframe software stocks plummeted in turn, most notably Computer Associates (NYSE: CA), Compuware (Nasdaq: CPWR) and BMC Software (Nasdaq: BMCS).
But some analysts weren't buying it.
"Given that there has never been a correlation between Mainframe hardware pricing (which has plummeted) and mainframe software pricing (which has held steady), this drop in IBM MIPs should have no immediate impact on CA, BMCS or CPWR," said Wendell Laidley, an analyst CS First Boston, in a research note.
Laidley points out that both Computer Associates and Compuware posted quarterly earnings this week that were either in line or well above most analysts' estimates.
"Considering the improving demand-side environment and strong fundamentals, we would regard any weakness in CA, BMCS and CPWR shares as a buying opportunity," Laidley said.
Another interesting subplot in this mainframe software debate surfaced Monday morning when SoundView Technology Group analyst Jim Mendelson cut Compuware from a "buy" to a "hold" recommendation hours before its third-quarter earnings report.
John McPeake, an analyst at Prudential Securities, said he didn't understand the downgrade, found no justification for it and predicted that Compuware would beat the Street estimate to boot.
McPeake was right.
Compuware did beat the Street by 3 cents a share, raking in $108.8 million, or 28 cents a share, on sales of $568.1 million.
Mendelson was unable to return several phone calls this week to comment on his downgrade.
Perhaps, Mendelson had some knowledge of IBM's slowing sales growth and Y2K concerns and therefore his downgrade was somewhat understandable. Maybe not.
Making matters even more complicated, IBM itself wasn't exactly throwing itself on its sword.
In the same release in which Gerstner called the third quarter "decidedly mixed," he also said "next year has the potential to be a very good year for IBM."
AOL's advertising growth rekindles excitement
It's hard for Wall Street to get too worked up about America Online Inc.'s (NYSE: AOL) strong first-quarter earnings report. That might be the greatest testament to its business model and investment potential.
It did beat the Street number by a couple cents a share, earning $184 million, or 15 cents a share, on sales of $1.5 billion.
But the most impressive part of the quarter, aside from growing its subscriber base to more than 19 million members, was the $350 million in advertising sales it recorded and the $2 billion backlog of ads its sitting on. That $350 million was double the $175 it recorded in the year-ago quarter.
AOL skeptics have been worried about low-priced or even free Internet service from a myriad of competitors. The theory goes that AOL will either lose a huge chunk of its customer base to lower priced competitors or it will lose the lion's share of its profits by cutting prices to compete.
Even the "disappointing" bumps found in this quarter's report and lined with good news. Gross profit margins fell to 46.1 percent from 46.2 percent in the fourth quarter, but most analysts said that's a result of users spending an average of 3 minutes more per day on its service.
After announcing a partnership with Gateway Inc. (NYSE: GTW) this week, AOL will now be shipped with every Gateway PC (which in the latest quarter was more than 1.2 million units) and take on Gateway.net's 600,000+ subscribers.
"We believe AOL's 20 million subscribers (including CompuServe) could turn into over 35 million once online usage hits maturity with AOL maintaining a 50+ percent penetration rate, which would value its subscribers using cable company comparisons at a conservative $220 billion, or about $182 per share," said James Preissler, an analyst at PaineWebber, in a research note.
Late Friday, AOL shares were trading at 123 1/2, off more than 42 percent from its 52-week high set in April.