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IBM shares slide on bad news for mainframe business

This week's profit warnings from BMC Software and Computer Associates mean Big Blue could be the next revenue casualty to step forward.

This week's profit warnings from BMC Software and Computer Associates mean another revenue casualty could step forward: IBM

IBM shares sank more than 4 percent this morning over concerns that mainframe and mainframe software sales are soft. Yesterday, big iron software developers BMC and Computer Associates took a dive because of slower than anticipated sales. Opening at $105, IBM shares dropped to $100 before a storage deal with Compaq lifted the stock to about $101 at the close of regular trading. Big iron is large and complicated computing hardware such as a mainframe used in the center of vast networks.

IBM has weathered two disappointing quarters, and another is expected when second-quarter results are announced on July 19.

Merrill Lynch and other analyst firms had predicted a turnaround in the second half, as mainframe sales rebound. Now, that rebound is uncertain and the short-term impact on IBM, because it sells hardware, software and services for his market, could be the harshest.

"We thought (the second quarter) would be difficult for IBM, but it appears there may be further risk to our numbers, though we are making no changes," Merrill Lynch analyst Steven Milunovich wrote in a research note today.

A different product segment each quarter seems to become a problem spot for IBM. In earlier quarters, disk drives and consumer PCs were disappointing. During the first quarter of the current fiscal year, despite gains in S/390 mainframes and modest improvements in AS/400 servers, IBM's hardware business declined 12 percent year-over-year.

"The problem we're seeing here is the Y2K hangover," said Gartner analyst Ray Paquet. Companies that bought extra mainframes for Y2K testing are now putting those systems into service rather than buying new ones, he said. A rebound likely won't begin until September.

Even then, anticipation for IBM's S/390 G7 server "could slow mainframe sales as customers wait for (it)," Paquet said. The new mainframe is due in the second half, with the first major customers expected to take delivery in the fourth quarter.

Analysts estimate Armonk, N.Y.-based IBM accounts for about 70 percent of mainframe sales, so any downturn in the market hits the company harder than rivals. Some competitors have already issued profit warnings.

Unisys, which competes against IBM in the mainframe and services markets, issued a profit warning that sent its shares tumbling 30 percent.

"Unisys has been a fairly good barometer for how IBM will do," Technology Business Research analyst Lindy Lesperance said. "When they warn of a difficult quarter, that usually means IBM also had troubles."

Along with hardware, software sales look tepid. During the first quarter, IBM had software revenue of $2.9 billion, with growth up negligibly from a year earlier. Analysts are forecasting little improvement, if any, for the second quarter.

Following profit warnings, BMC stock yesterday closed down 40 percent and Computer Associates finished 42 percent off its opening price, after setting new 52-week lows and being the subject of many analysts downgrades.

Other areas investors may be counting on to lift IBM's second-quarter revenues may also disappoint. Milunovch last week lowered his second-quarter growth estimates to 1 percent from 3 percent over concerns about IBM's services business.