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The duo's strong third-quarter results indicate the sector hasn't been hurt by housing's troubles or the credit crunch. But can it last?
Tech bellwethers Intel and IBM offered fresh evidence that the housing slump and financial malaise are separating the economy's haves from its have-nots. Both companies—the haves, in this case—reported third-quarter gains Oct. 16 that exceeded analysts' expectations in key ways. For Intel (INTC), the world's largest maker of computer chips, profit and sales outstripped analysts' expectations on robust demand for personal computers and the semiconductors that make them run.
At IBM (IBM), sales of computer services rose at the fastest pace in four years. It was enough to exceed the forecasts of some analysts, and more important, offset a drop in demand from some of the most notable have-nots: financial-services firms. IBM Chief Financial Officer Mark Loughridge told analysts on a conference call that U.S. banks and brokerages scaled back spending. That affected U.S. results especially in the area of mainframes, the hulking machines that help companies tackle mammoth data-processing tasks. "Given that the financial-services sector was uncharacteristically the poorest performing segment…and that they are big consumers of both mainframes and related software, there is at least a hint that the credit crunch may have affected the demand in the third quarter," notes Bob Djurdjevic of Annex Research.
Taken together, the results underscored why the often-volatile technology industry has been a relative oasis of calm amid recent turbulence in financial services and other areas of the economy affected by the subprime mortgage meltdown and pullback in credit. But the third-quarter performance also served as a reminder of ways the contagion could spread (BusinessWeek.com, 10/15/07).
IBM said sales rose 7%, to $24.1 billion, helping lift profits 16%, to $1.68 a share. The company chalked up that performance to a 14% increase in global-services revenue, which made up for slowing growth in software and a 10% decline in hardware, led by a 31% drop in mainframe revenue. IBM Chief Executive Officer Sam Palmisano called the services performance "outstanding." Analysts now will be on the lookout for signs that cutbacks in financial services will continue to drag otherwise positive results heading into the end of the year. The stock slipped 1.2%, to $118.19, in extended trading.
For its part, Intel reported a profit of $1.9 billion on sales of $10.1 billion, outdistancing forecasts that had averaged $9.62 billion. Per-share profit was 31¢, versus an average estimate of 30¢, an improvement of 40% over a year earlier. Gross margin, a key indicator of the company's health, widened more than five percentage points, to 52.4%, from the prior quarter. Shares of Intel jumped 5.1%, to $25.48, in extended trading.
What's unclear is whether consumers will show up in sufficiently high numbers in the all-important fourth quarter to keep the Intel locomotive on track. Concerns about a buildup of inventory have led some analysts to lower ratings on Intel in recent days. Robert Burleson of Thinkequity Partners wrote in an Oct. 11 note that Intel's exposure to the PC market could become a liability in the first quarter of 2008 when sales are generally weaker than at other times of the year.
Another downgrade came from Merrill Lynch's (MER) Srini Pajjuri, who argued that Intel had reached the "high end of its valuation range."
Additionally, reports and rumors in recent weeks have suggested that PC makers had ordered more chips than they needed in advance of the fourth quarter, suggesting that demand might slow. Intel CEO Paul Otellini dismissed those concerns. "I have seen those reports, but we haven't seen it in the marketplace or in the requests from our customers," he said in response to a question during a conference call with analysts. In the first quarter of 2007 there was a serious glut of unsold chips (BusinessWeek.com, 4/4/07) left over from the 2006 holiday season.
Chipmakers have been helped by an unusually strong demand for PCs that started in the second quarter of the year and has held strong in the third. It seems to be continuing into the fourth quarter. JP Morgan (JPM) analyst Bill Shope recently raised his forecast for 2007 PC sales to grow by 11.6%, versus a previous forecast of 9.6%, and market research firm IDC in September upgraded its own forecasts for the year as well. "From what I'm hearing, demand in October and November is shaping up to be pretty good," says Edwin Mok, analyst at Needham and Co. in San Francisco.
Can the demand last? It depends on how much confidence you have in consumers. Cody Acree, analyst with Stifel Nicolaus (SF), predicted a solid fourth quarter. "It's been an error to bet against consumer spending in the fourth quarter in each of the last five years," he says. He compared the outlook to the fourth quarter of 2005, when retailers and manufacturers prepared for slowed spending in the wake of hurricanes Katrina and Rita and increased energy costs, but saw strong sales despite them.
Indeed, Intel painted a positive picture for the coming quarter, saying that gross margins would hit 57%. CFO Andy Bryant attributed most of the margin increase to lower per-unit costs on microprocessors, chipsets, and flash memory chips.
"Certain sectors may be weak, but we're seeing decent demand from Dell (DELL), HP (HPQ), Nokia (NOK), and Motorola (MOT)," Acree added. "There is enough reason to be concerned, but not enough to call the game over. In the end, unemployment is low and job growth is decent. When people are employed they spend."
Assuming consumers and businesses keep spending on PCs and information technology services, companies like Intel and IBM will remain in the haves column.