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Mainframes, E-commerce, and services have it soaring

Pop quiz: What computer company's stock has skyrocketed 50% since June--and it's not an Internet startup or a pure play in software or personal computers? The answer: IBM(IBM). Shares of Big Blue, which is in all those businesses and more, are hovering around $160, up from $106 in June. That's right up there with Dell Computer Corp.(DELL)--and well ahead of Microsoft Corp.(MSFT), whose stock is up approximately 16% in the same period.

Why are investors so giddy about a high-tech company whose last name isn't ''.com''? IBM seems to be overcoming its growth problem. For the first half of 1998, revenue grew just 1%, owing to abysmal hardware sales, weak international business, and an anemic software unit. But with the business climate improving in Europe, new mainframes, and its PC unit working off an inventory glut, IBM generated 8% revenue growth in the quarter ended Sept. 30--a rate it hasn't seen for two years. That blew by Wall Street forecasts of 3.5% growth. ''We're clicking on all cylinders,'' says IBM Chief Financial Officer Douglas L. Maine. Analysts, enthralled by IBM's string of earnings gains, say the stock could hit $185 in the next 12 months.

What's driving the growth? Part of it is cyclical: For decades, IBM has enjoyed a growth spurt when new mainframes ship. And the G5, which began reaching customers in September, has kept up the tradition--accounting for a 20% boost in mainframe sales in the third quarter.

But there's more. While IBM is no Yahoo!, it is a major player on the Web. On Nov. 11, CFO Maine told analysts that up to 33% of this year's revenue--$27 billion--will involve E-commerce applications, both hardware and software. IBM is even getting Web-savvy itself: It's selling online $7 million a day worth of such gear as PCs and disk drives. Dell Computer Corp., the current king of online computer sales, does $10 million a day.

Then there's the $19.3 billion high-tech service business that has been growing more than 20% quarterly for six years. Until recently, such services as outsourcing were mostly a U.S. phenomenon. But big service deals, such as the $2.4 billion contract IBM signed with Cable & Wireless Ltd. in September, are starting to open up overseas. Now, IBM has a $49 billion backlog of service contracts. That should smooth the bumps in future hardware product cycles.

DOWNSIDE. What could slow IBM's momentum? For starters, there's the Year 2000 problem. It could be a boon, as customers require more gear and services. Or customers could postpone new orders for big-ticket items such as mainframes to focus on fixing existing programs. That chance led Gary Helmig of SoundView Financial Group Inc. to cut his estimate of IBM's revenue growth to 7%, from 10% for 1999. Concedes Maine: ''It's difficult to determine whether Y2K will be a risk or a benefit.''

In addition, the mainframe boom will subside in 1999, when most customers will have traded up. Then mainframe sales will resume their long-term, downward trend. Helmig predicts mainframe sales will decline 10% next year from an estimated $5.5 billion this year.

What's more, in its PC business, IBM, like Compaq (CPQ)and Hewlett-Packard(HWP), is trying to come up with a distribution strategy that can match Dell, which profits handsomely by selling direct. A roller-coaster operation for IBM, the company's PC unit eked out a modest profit last quarter, after losses during the first half of 1998. IBM has a senior exec studying the possibility of direct sales. The company already sells some PCs that way, but analysts don't expect it to go entirely direct. Such a strategy could backfire if it turns off IBM's dealers.

IBM may have to fight to maintain its PC services revenue, too. Rick Nathenson, head of the services unit of Entex Information Services Inc., says his company has replaced IBM at up to eight companies, including AlliedSignal(ALD), which has 30,000 PCs. IBM says desktop services revenue continues to grow.

So far, investors are bullish. Wonders Helmig: ''If there is a slowdown in the second half, will investors look right through it?'' If they have stuck with IBM through the years of lean growth, then the answer is probably yes.

By Ira Sager in New York


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Updated Nov. 19, 1998 by bwwebmaster
Copyright 1998, Bloomberg L.P.
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