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Tech Industry

THE DAY AHEAD: IBM, the Teflon tech stock

COMMENTARY--Money managers have to buy at least a few technology stocks. That fact may be the best theory you can come up with to explain why IBM shares are holding value as the tech sector crumbles.

IBM (NYSE: IBM) shares are coated with Teflon these days--no bad news sticks. Oh sure, IBM has dipped a bit, but it's still about $100, about $32 from its 52-week high. Not bad at all considering the tech wreck and daily 52-week lows hit on the Nasdaq.

In January, we explained why Big Blue and its 6 percent sales growth looked so good to investors. IBM is defensive. It's a diversified technology company and is run by managers who have been through a downturn before.

But since that last column, things have gotten worse. Information technology spending has slowed even more. Tech highfliers such as Cisco Systems (Nasdaq: CSCO), Brocade Communications (Nasdaq: BRCD) and Sun Microsystems (Nasdaq: SUNW) have fallen. It's so bad that Wall Street analysts are being proactive by cutting estimates across the board before tech companies actually warn. Why? They're too pooped from chasing profit warnings everyday.

But IBM is still standing. How long will it last?

Probably not for long. The stock is below $100 now, and the debate on Wall Street is just warming up. Wall Street is sticking by IBM because it's a pillar of strength and there's perceived safety. It's not going to grow, but it's not going to implode either. However, I don't see how a betting man could not conclude that IBM won't either issue a profit warning or lower estimates when it reports earnings in April. IBM is expected to report 2001 earnings of $5 a share. Can it deliver?

Analysts seem to think IBM can handle anything. In fact, SG Cowen analyst Stephen Weber penned a why-we-love-IBM intraday research note on Wednesday. His points are valid, but he's stretching.

Weber argued that IBM's profit model is uniquely stable because it doesn't rely on hardware sales and 60 percent of its revenue comes from outside the United States. International business hasn't been infected by the U.S. slowdown--yet. Weber is so convinced IBM is the best thing going that he has the company pegged to earn $5.20 a share in 2001, 20 cents above consensus estimates.

According to Weber, IBM shares have the potential for a 50 percent gain over the next 12 months. He has a $160 target price for the stock assuming "just a moderate upward move in the market." To Weber, IBM shares are cheap because Big Blue is performing better than many premier growth companies right now.

The crux of Weber's argument is that IBM depends on services, software and sales to original equipment manufacturers and royalties for its revenue. IBM can avoid the cyclical problems with hardware. Assuming no global recession, Weber said IBM can hit his earnings targets.

And Weber argued that IBM will post strong revenue growth in the first quarter and much of Big Blue's results will be logged in the first half. In 2002, Weber sees IBM reaching double-digit revenue growth, a feat that hasn't been accomplished consistently for years.

Weber's projections are hard to take. If the guy's right, you gotta give him--and his rose colored glasses--credit.

But it's hard to overlook the following problem areas.

• The PC business isn't getting better. PCs were actually a bright spot in IBM's fourth quarter (it's all relative), but it's hard to ignore the struggles of Dell Computer (Nasdaq: DELL), Hewlett-Packard (NYSE: HWP) and the rest of the bunch.

• IBM's server business was middling in good times. When Sun Microsystems (Nasdaq: SUNW) hits a dry patch, IBM's server business isn't going to do that well.

• IBM's software sales declined in the fourth quarter, and the IT spending slowdown isn't going to help matters.

• Is mainframe spending discretionary? Tech execs have made it clear that capital spending is being cut. We know all about IBM's new mainframe product cycle, but it can't be immune.

• Even storage is suffering. EMC (NYSE: EMC) cut its growth targets and that theory about bulletproof storage companies disappeared. Ditto for Brocade Communications (Nasdaq: BRCD). IBM did hold an upbeat conference call Wednesday about its new storage products and how it's targeting EMC, but didn't talk about current economic conditions.

• Services invincible? Services are the crown jewel of IBM's business. All this e-business integration requires an army to put it all together. In fact, rivals Electronic Data Systems (NYSE: EDS) and Computer Sciences Corp. (NYSE: CSC) are also doing well. But if customers are really putting off their previous e-business plans, IBM's services business is going to suffer no matter how much work is in the pipeline.

• If the U.S. economy continues to falter it's going to spill over to the rest of the world. It's a small world.

There is a chance that investors will love IBM even if it issues a profit warning or cuts estimates, but don't bet on it. Relative to other momentum-driven rivals, IBM still looks safe. But it may not be as safe as you think.

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