Technology

Investors See IBM Outside Tech's Recovery


Third-quarter earnings beat expectations and IBM raised its full-year profit forecasts, but a decline in contract signings disappointed Wall Street

Try as it might, IBM (IBM) couldn't make a convincing case to investors that it's reaping the benefits of the economic recovery that is lifting other tech companies.

Even as it raised full-year profit forecasts and beat expectations for third-quarter earnings, IBM also reported a decline in contract signings, a yardstick of future business. Investors and analysts took the decline as a signal IBM isn't seeing demand rebound as quickly as some other tech providers. "The signings number was pretty low," says Brian Marshall, an analyst with Broadpoint AmTech Research in San Francisco. "Today's announcement will be viewed as a disappointment."

Armonk (N.Y.)-based IBM said new signings dropped 7% to $11.8 billion. Marshall expected signings of $13 billion.

The shortfall overshadowed other more upbeat numbers, including a 14% rise in profit to $3.2 billion. IBM also boosted its forecast for 2009 profit to $9.85 a share. That was the third increase in the forecast, which in January was at $9.20.

The higher forecast is in line with a seasonal bump that IBM and other large IT companies see in the second half, Marshall says. "IBM usually grows sequentially 16% in the December quarter," as corporations and governments use up unspent money in their IT budgets, Marshall says. "The Street wanted more. We need to see the whites of the eyes of the recovery." Marshall gives IBM a neutral rating with a 126 price target. Shares fell more than 3% in extended trading to 123.46. During the regular trading day on Oct. 15, IBM stock slipped 0.3% to 127.98.

Outsourcing Deals

In the fourth quarter, IBM expects to reverse the trend of declining revenue that's been in place for a year, Chief Financial Officer Mark Loughridge told analysts on a conference call, though he didn't specify by how much. Analysts expect sales of $26.8 billion for the fourth quarter and $95 billion for the full year.

Loughridge also said he expects double-digit growth in IBM's outsourcing services business in the fourth quarter. He said three deals worth a combined $1 billion were signed during the first two days of October just after the close of the quarter. "These three deals would have pushed our outsourcing growth rate to 16%," consistent with the 18% growth seen during the first half of the year. The company signed $6.7 billion in outsourcing deals in the third quarter, an improvement of 1%.

Sales fell in IBM's hardware and services businesses and were flat in its software division.

The company achieved margin growth through cost reductions and sales of higher-margin products such as software. Gross margin, which measures profitability, widened by 1.8 percentage points to 45.1%. Loughridge said the shift to software accounted for almost one-third of the margin improvement. IBM has grown its margin in 20 of the last 21 quarters, Loughridge said. The company's results were also helped by a weak dollar, which contributed nearly half of an 11% drop in expenses.

More Cost-Cutting

During the conference call with analysts, Loughridge was asked by Bernstein Research analyst Toni Sacconaghi whether he believes corporate IT spending has recovered in light of what he called "tepid guidance." Loughridge said IBM is seeing an overall stabilization in the economy. He reiterated that the revised earnings-per-share (EPS) guidance reflects "the confidence we have going into the fourth quarter."

Loughridge also hinted at further savings and acquisitions. He said IBM expects to finish the year having reduced operations expenses by $3.5 billion. The company cut 9,000 jobs in the first half of the year. Loughridge suggested more cost cuts could be in the offing. "We've got a lot of opportunity to continue to reduce structure and make our business more efficient," he said.

He suggested IBM will consider returning some cash to shareholders in the form of share buybacks and perhaps another boost in its dividend, currently at $2.20 a year.

IBM has in recent years shifted the majority of its business away from computing hardware and toward services such as advising large companies and governments on their technology operations, and incurring more stable recurring revenue. "Hardware sales follow industry trends, but that's now less than a quarter of IBM's business," says analyst Bob Djurdjevic of Annex Research. "With services during flush times IBM helps companies grow, and during tough times it helps companies save."

Hesseldahl is a reporter for BusinessWeek.com.

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