Sales, not profit, may tell story for IBM

Though the company is likely to meet earnings expectations Tuesday, the more important measure may be the company's revenue.

5 min read
Though IBM is likely to meet earnings expectations Tuesday, the more important measure may be the company's revenue.

IBM wavers
Stock price from October 1999 to present.  
 Source: Prophet Finance
After the stock market started to swoon in September, analysts shifted their focus from profits to sales. The question on everyone's mind, and the one that will be partially answered in conference calls this week and next, is whether sales of technology services and equipment are slowing.

IBM may be hard pressed to meet revenue expectations in what could be a revealing trend. While Wall Street has traditionally focused on income, revenue may be the more important metric of growth during a volatile period, analysts say. Many companies, among them IBM, may be looking to cloud larger market problems by downplaying smaller revenue growth in favor of income.

"What you're looking for so much isn't whether IBM is going to meet their earnings but what their revenues will be," said Technology Business Research analyst Bob Sutherland.

"Earnings can turn into a numbers game," he said. "For example, you can buy back a number of shares and increase earnings a couple of pennies. That's usually the big problem. So people looking at Dell or IBM might see them making their earnings, but their revenues fall short."

Any revenue shortfall is expected to be multifaceted: lost sales due to component shortages; improved but still sluggish mainframe and server sales; currency effects slowing sales in Europe; and an unexpected retail sales decline in Japan, among other things. Still, IBM is expected to see a big boost over the first two quarters, when lingering Year 2000 sales sluggishness sapped revenue.

Consensus earnings estimates for IBM, according to analysts polled by First Call/Thomson Financial, is $1.08 per share for the third quarter, $1.48 for the fourth quarter and $4.45 for the year.

Getting a consensus of revenue is harder, with many analysts predicting a range for growth, anywhere from 5 percent to 8 percent. IBM's guidance has been more in the 7 to 8 percent range, but in recent days some analysts warned this is too high.

"We expect IBM will miss consensus revenue growth of 7 to 8 percent as a result of continued currency pressures and will likely come more in-line with our growth estimate of 5.4 percent," Prudential Securities analyst Kimberly Alexy wrote in a research note Monday. Alexy predicted earnings per share of $1.07.

Merrill Lynch analyst Thomas Kraemer, by contrast, on Monday raised his third-quarter IBM estimate to $22.5 billion in revenue from $22.2 billion. He raised his earnings estimate to $1.10 per share from $1.07. Kraemer reiterated his "accumulate" rating for IBM but also raised his earnings estimate for the entire year to $4.48 per share from $4.45.

That is still short of the consensus estimate of around $22.6 billion.

If, as in the second quarter, IBM meets or beats the Street but misses revenue expectations, it could be a sign of leaner technology sales going forward, particularly PC sales, analysts warn.

Sutherland estimates that about 75 percent of IBM's revenue will come from traditional hardware, software and services, and the remainder from e-business. IBM's reliance on system sales, even with higher-margin, high-end products, still makes the company highly susceptible to any slowdown in the market, he said.

Such an outcome would be consistent with weakness in Gateway's third-quarter earnings revealed last week. Though Gateway met expectations, the company refused to reveal PC unit shipments and derived 50 percent of income from services and software sales. That "says a lot about where the money's coming from," said IDC analyst Roger Kay.

"It's been known for a while that Gateway has been shifting its mix because of the decline of the desktop market," Kay added. "Anybody whose segment mix favors decreasing dependence on the heretofore dominant desktop market is in better position. IBM, for example, can benefit from enterprise sales and services. That helps offset any kind of slowing in the PC market."

As IBM pushes into the second half, the company hopes to leave behind Year 2000 woes that sapped services, mainframe and large-server sales during the first two quarters. A misstep with disk drives and problems selling memory also hurt but are expected to be largely resolved.

Kraemer in a research note on Monday predicted IBM would see year-to-year growth in most hardware areas, with the company "doing very well with RS6000 Unix product line and also showing strength in PCs."

Earlier in the month, Kraemer predicted 38 percent year-over-year growth for mainframe sales and 10 percent for global services.

The mainframe pickup is expected to be a big boost for enterprise sales, but they will still be slower than last year and off somewhat in anticipation of the new eServer line. IBM unveiled the first eServer products Oct. 3 and expanded the line Monday.

Currency problems in Europe are expected to hurt IBM, as they did Intel and Dell Computer. But Big Blue also is struggling in one of the hottest PC markets: Japan. Sources familiar with the situation say IBM retail sales dipped unexpectedly in the third quarter, and, as a result, inventory is building up on dealers' shelves.

IBM's PC division, which sells desktops, portables and Intel-based servers, is expected to break even "or come pretty darn close," Kay said.

One problem is ongoing supply issues that sapped $250 million sales in the second quarter and could hurt the PC division during the third quarter. Because of a single component shortage, the PC group had trouble delivering portables and servers, the only profitable products it sells. The division also sells desktop PCs and peripherals.

The division is also more susceptible to shifts in the PC market. That could be a problem in the fourth quarter, Kay said. "It seems that the third quarter was not victim to the worst of the forces that seemed to be gathering.

"Q4 is still the one in jeopardy," he added, referring to the overall PC market. "Growth rates in the past have shown that IBM is the weak sister of what was known in the past as the Big Four."