Merrill Lynch whacks HP and IBM

The downgrades for leading information technology companies just keep coming. HP and IBM are the latest victims as Merrill Lynch downgraded both stocks to "neutral."

Hewlett Packard (NYSE: HWP) and International Business Machines (NYSE: IBM) joined the ranks of Sun Microsystems (Nasdaq: SUNW), EMC (NYSE: EMC) and others Wednesday, getting downgraded due to slowing IT spending.

And things aren't about to get better soon, judging from Merrill Lynch analyst Thomas Kraemer's research note. "The downturn in IT spending that we have already seen could worsen as the economy does," the analyst said in a research note. Merrill Lynch is forecasting that the economy will continue to slow. HP shares closed up 0.19 to 31.31 and IBM shares closed down 0.38 to 90.13.

Kraemer downgraded HP from "near-term accumulate" to "neutral," and suggested a $40 valuation for the stock.

"Given the fundamental risks, slowing IT environment, and poor Unix orders, we do not think there is positive risk reward at current levels," Kraemer said in a research note. In just one month, from October to November, the amount by which most companies planned to increase their IT spending dropped by 22 percent, according Merrill's research.

The analyst also said channel checks suggest another disappointment from the company.

"We believe that a concerted effort by HP to drive Linux, improve its channel relationships, and continued success with color could materially improve our outlook. But we'd like to see those things happen," the analyst added.

Kraemer also downgraded IBM from "near term accumulate" to "neutral," based on similar concerns of slower IT spending. He also said long-term fundamental issues may place second quarter and 2001 revenue and earnings estimates at risk.

Kraemer also lowered estimates for the second half of fiscal 2001; revenue for fiscal 2001 was cut from $94.3 billion to $93.0 billion and earnings per share estimates for the 2001 went from $4.93 to $4.87.

Surveys suggest strength in IBM's RS/6000 or iServer line, but spending for mainframes will decelerate over the next two years.

The analyst said his IBM call was difficult for three reasons: he expects the company to benefit from three product cycles (mainframe, RS/6000, and Shark) over the couple quarters, it is finally on track with Unix servers and storage, and management's strategy looks good.

"Were it not for the surprising and dramatic change in spending intentions from October to November we would not be downgrading," Kraemer added.