IBM drops amid analyst downgrades

Big Blue fell more than 20 percent in early trading before climbing back to close at $95.50, a drop of $17.50, more than 15 percent. Wall Street analysts piped in with a string of downgrades after the Armonk, N.Y.-based computing giant delivered revenue growth that was half of expectations.

Prudential Securities analyst Kimberly Alexy cut IBM to "hold" from "accumulate" and downgraded her fourth-quarter and fiscal 2001 earnings per share (EPS) estimates: $1.39 from $1.46 and $4.84 from $5.03. She also cut her price target to $111 a share from $130.

Deutsche Banc Alex Brown analyst Philip Rueppel cut IBM to "market perform'" from "strong buy." Stephen Dube at Wasserstein Perella Securities downgraded IBM to "buy" from "strong buy." Goldman Sachs analyst Laura Conigliaro cut IBM to "market outperform" from "recommend list."

Merrill Lynch analyst Tom Kraemer cut his fourth-quarter EPS estimate to $1.46 from $1.50 and lowered projected revenue growth to 6 percent. He also cut his 2000 EPS estimate to $4.43 from $4.48 and his 2001 share estimate to $4.93 from $4.99 on projected revenue of 7 percent. Kraemer lowered his price target to $130.

Before IBM announced third-quarter results, a consensus of analysts polled by FirstCall/Thomson Financial put EPS at $1.48 for the fourth quarter and $4.45 for the year.

While IBM met consensus expectations of $1.08 per share on sales of $21.8 billion and income of $2 billion, revenue grew 3 percent or about half the most conservative estimates. Many analysts had been looking for revenue growth more in the 7 to 8 percent range.

IBM chief financial officer John Joyce delivered the bad news on Tuesday in a conference call with analysts following the market's close. In what could be described as a chilling reception, Joyce emphasized earnings over revenue, which did not seem to satisfy financial analysts more concerned with sales.

"IBM's fundamental issue, in our opinion, has been a lack of demand for its key platforms," Kraemer wrote in a research note on Wednesday.

Analysts' reactions to slow sales raise questions about IBM's financial health and could explain the deeper reasons behind a management shake-up in July.

After three quarters of flat revenue growth, many financial analysts had predicted a rebound in the second half as IBM shook off the lingering Year 2000 sales slowdown. Kraemer was so bullish he raised EPS estimates Monday to $1.10 from $1.07 and revenue estimates to $22.5 billion from $22.1 billion.

But with yet another quarter of slower-than-expected sales, analysts may take a harsher look at how IBM crunches its numbers.

Technology Business Research analyst Bob Sutherland said lower taxes and a stock buyback of $1.4 billion "helped make their numbers." The savings on the tax rate added about $84 million to net income, or close to 5 cents a share, he added.

Cash flow is another indicator of deeper problems at IBM, Sutherland said. "They have not had positive cash flow since 1996. They're not generating as much as they're spending, and this is a problem."

Year to date, IBM has negative cash flow of $2.8 billion, up from minus $322 million in 1999 and negative $1.7 billion in 1998.

Other issues may give Wall Street reason for concern.

Joyce told financial analysts that shortages of the ceramics used in chips prevented IBM from fulfilling orders for RS/6000 and AS/400 servers, which are typically higher-margin products.

"Given the uncertainty of a supply constraint, we expect IBM to be fairly volatile over the next few quarters," Kraemer wrote in his research note.

IBM also fumbled the transition from S/390 mainframes to new z900 servers unveiled Oct. 3 and scheduled for mid-December shipment.

"Although back in July we thought our transition plans would minimize the impacts on orders of our (older) models, in the later stages of September new orders in the pipeline started to slow, and some existing orders were even deferred," Joyce told financial analysts Tuesday.