Big Blue earnings spark big debate

No news has been good news for IBM so far. But suspense is mounting ahead of the company's first-quarter report as a rift on Wall Street deepens.

On one side stands the doubters who believe Big Blue will cut its outlook for 2001, on the other, those who believe IBM, the last untouched technology company, can escape the IT slowdown unscathed.

Any change in IBM's outlook could have broad ramifications on Wall Street. While other tech bellwethers--such as Intel, EMC and Cisco--have issued profit warnings, IBM shares have remained relatively immune to the information technology slowdown. Analysts have cited its diversified business, which includes a predictable profit stream from services, software and financing operations.

Shares in the company have been hovering around $98 per share this week, off 36 percent from their 52-week high of $134.93. That's not bad compared to the Nasdaq's 62 percent plunge from its highs.

As for its first quarter, there's no doubt IBM will hit the mark. First Call's consensus of 11 analysts has pegged the company for revenue of $20.79 billion in the first quarter, and a consensus of 16 analysts have put earnings at 98 cents a share. In fact, some analysts are betting the company can beat those numbers.

UBS Warburg analyst Don Young is so optimistic about IBM's quarter that he raised his earnings estimate Tuesday. The analyst, who holds a "strong buy" on the stock, now expects IBM to bring in 99 cents a share, rather than 95 cents a share.

"We believe IBM is a safe harbor in the storm," wrote Young, who said his last-minute change to estimates reflects evidence of strong performance in IBM's hardware segment.

Young also expects the company to maintain June quarter guidance, in stark contrast to the rest of the tech universe, and anticipates a very bullish analyst meeting in early May.

Bernstein analyst Toni Sacconaghi was also on the bullish end of Wall Street's scale. His earnings estimate is for $1.02 a share and his revenue estimate is for $20.6 billion, up 6 percent.

The fact that over half of IBM's earnings are recurring or resulting from backlogs makes it very well positioned, especially compared with other players such as Sun Microsystems (Nasdaq: SUNW), where less than 15 percent of operating profits are recurring.

Sacconaghi, who held his "outperform" rating said he also expects the company to reaffirm earnings outlook for the upcoming second quarter. First Call's consensus is $1.17 per share, with revenue pegged at $23.2 billion.

The doubters
But some analysts questioned the company's ability to maintain its projections. IBM's current outlook calls for growth of about 6 percent for 2001. First Call's consensus has put revenue at $94.10 billion and earnings at $4.87 per share for the year. If that changes, IBM could lose its luster as a bulletproof stock.

Sacconaghi actually lowered his fiscal-year revenue growth forecast to 6 percent to 7 percent and cautioned the company may not provide concrete revenue or earnings targets for the remainder of the year.

Dresdner Kleinwort Wasserstein analyst Stephen Dube was also cautious about the company's outlook.

Dube cautioned that the outlook for the balance of the year may be less positive that currently expected, after all "the first quarter of 2001 is generally conceded to have been the most difficult for the computer industry in more than a decade," he cautioned. "All the business areas that IBM participates in have been lackluster, and two of its major industry customers have been notably weak," Dube wrote.

J.P. Morgan analyst Daniel Kunstler was definitely one of the doubters. The analyst reduced his earnings estimates for the company's June and September quarters and called IBM's thus-far immunity to the slow-down "enigmatic."

Though its diversity--the combination of revenue from services and software licenses, combined with a fresh product line-up in mainframes and Unix--may have served as armor for this quarter, Kunstler is less convinced it can offset the pressure on IT spending for the rest of the year.

"There is no indication of marked improvement in the near-term outlook governing IT spending," Kunstler explained.

Areas to watch
Here's a look at what analysts will be expecting from the company's quarter.

• Strength in hardware

IBM's hardware business accounts for an estimated one-third of gross margins, and is currently in a strong product cycle.

Young's eleventh-hour lift in earnings estimates was based on the expectation that it's doing gangbusters. He said both the higher-margin zSeries mainframes (previously known as S/390) and the pSeries (or R/S6000) servers should turn in a stronger-than-planned performance.

IBM is also expected to give indications that both product lines will be strong through the June quarter.

• The PC and Personal Systems divisions

Though the PC division is benefiting from IBM's decision to exit the consumer/retail marketplace, the recent reshuffling of operations could put its Personal Systems division in trouble. The company's lower-revenue-generating printer operations have now replaced the high-margin Netfinity Servers operations that were shifted into the Enterprise Systems Group. That might just be enough to put the Personal Systems division in the red, Young noted.

• Services

Strong performance is also expected from the company's services and financing division, which should see the benefit of backlog, business visibility and recurring revenue streams.

There could be some weakness in new contracts this quarter though, Sacconaghi cautioned. Signings could be worth less than $10 billion, compared with signings of $12.5 billion in each of the last three quarters, which "may alarm some investors," he said. But the analyst also predicted that next quarter's signings will be strong, given that the giant NTT Communications deal, valued at up to $15 billion, should be booked in the second quarter.

• Software

The company's software business is expected to remain mixed, with stable monthly license fees for mainframe and ongoing problems with Tivoli, IBM's enterprise-management software.

• International

Currency exposure will be a huge risk for the company. Though analysts believe that IBM has hedged their earnings exposure from the currency fluctuations, results on the top line could be slightly less than expected as a result of Euro fluctuations.

"Top line growth is likely to be closer to 3 percent to 4 percent than the 5 percent to 6 percent estimate we made at the beginning of the quarter," Young wrote.

Analysts will have a close eye on the company's European business, which has been the latest thing to trip up its peers.

"We believe that (IT spending) pressures will hop a plane to Europe in the absence of a prompt--and improbable--rebound in the U.S.," Kunstler said.