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OCTOBER 12, 2004
By Jim Kerstetter Tech Earnings: Now It's Software's Turn A cycle appears to be emerging in tech's post-bubble world: Hardware stocks soar while software slumps, then they swap roles The tech industry's blasé year is quickly morphing into what comedian Jerry Seinfeld would have called The Year of Even Steven. With a range of big tech companies, including Intel (INTC ), Sun Microsystems (SUN ), Yahoo! (YHOO ), and Texas Instruments (TXN ), set to report third-quarter earnings in the coming days, analysts are becoming more optimistic about results from long-suffering software companies just as they're cooling on tech's computer and semiconductor sides. "The good news is over," says a glum Ben Lynch, a chip analyst with Deutsche Bank in New York. Just a quarter ago, it was the opposite. While a raft of computer makers and chip outfits such as Advanced Micro Devices (AMD ) and TI handily beat sales expectations, nearly two dozen software makers came up short. This time around, with expectations comfortably pulled back, names like Siebel Systems (SEBL ), Computer Associates (CA ), and even embattled business software maker PeopleSoft (PSFT ) have announced quarters that met modest sales goals. TOUGHER SHOPPERS. Why the turnabout in fortunes? Some analysts believe they're starting to see a post-boom tech purchasing cycle. Corporate America is still buying computers. It's still buying software. But it rarely buys both at the same time. At the end of a two-year cycle, it's now software's turn to shine, since hardware has had its day. As Seinfeld said in a 1994 episode of his comedy series: "You see how it all evens out for me?" Of course, there's more to this spending pattern than a Seinfeld quip. A survey of 200 corporate tech buyers in the U.S. and Europe conducted in September by Smith Barney, a division of Citigroup Global Markets, found that chief financial officers are becoming more engaged in tech spending. That means big projects, like corporate software systems sold by the likes of Siebel, are taking longer to get approved. It also means "seasonal" software spending is likely to get even more extreme, with the fourth and first quarters strong, the second quarter extremely weak, and the third just a little better. BACK-TO-SCHOOL BLUES. The Smith Barney survey also found that tech buyers are still nervous about the overall economy. Just 30% of the respondents said they believe spending will accelerate in the second half of the year -- down 10 percentage points from a similar survey conducted in June. In short, they're buying, but they're being choosy. Intel will be first out in the earnings parade when it reports after the close of trading on Oct. 12. Many believe the chip cycle has peaked, which will lead to slower growth than originally expected in coming quarters. Tim Luke, semiconductor analyst for Lehman Brothers, expects the chipmaker's revenue to come in toward the lower end of Intel's guidance of 3% to 8% growth. The main reason is softer-than-expected sales of desktop PCs because of lackluster back-to-school demand, he says. That should be offset by better sales of notebook PCs and servers. Weakening demand is also unlikely to have reduced Intel's inventories, which have climbed to more than 90 days, the highest in more than a year, Luke estimates. TI'S COLD. After several years of red-hot performance, chipmaker TI appears to be cooling off. Investors first got an inkling of that when the outfit, which makes chips for cell phones and digital TVs, lowered third-quarter revenues guidance in early September. That sneeze has, by now, developed into a full-blown cold: On Oct. 11, right before the earnings announcement, Deutsche Bank lowered its rating on the stock from buy to sell, sending the shares down to $21.75 in after-hours trading. At first glance, TI's third-quarter earnings, which will be released on Oct. 18, appear healthy enough. Analysts polled by financial service Thomson One expect net income of $489 million on $3.17 billion in sales. That's up significantly from last year, when TI booked a $447 million profit on $2.53 billion in revenue. The problem is the financial performance is running out of steam. As the industry enters its cyclical downturn next year, chip companies will come under pressure. TI will suffer more than many, says Lynch. TI's top line will grow only 4% next year, vs. 27.5% in 2004, Lynch estimates. iPOD CHARGE. Sun is in the odd situation of being a computer maker trying like crazy to jump-start its software business. And after three years of declining year-over-year sales, Sun managed to get itself turned in the right direction in the second quarter, posting a modest, 4.3% sales increase. Analysts believe third-quarter results, set to be announced on Oct. 14, will continue moving in the right direction, with sales up 6.9%, to $2.71 billion. Consumer tech buyers don't appear to be as finicky as their corporate counterparts. Apple Computer (AAPL ) is expected to announce another strong quarter after the market closes on Oct. 13, thanks in large part to healthy sales of the iPod digital-music player. Revenues are pegged to come in at $2.15 billion, according to consensus estimates, up about 25% from a year ago. Profits are expected to be up nearly 60%, topping $65 million. Also on the consumer side of tech, analysts are expecting big things from Yahoo's third-quarter results, to be announced on Oct. 12. Analysts at Goldman Sachs and Jeffries & Co. expect the Web portal to beat expectations because of the continuing surge in online advertising. The Wall Street consensus predicts Yahoo will notch profits of $130 million on revenues of $644 million. Such numbers would represent a doubling of profits from a year ago and an 80% leap in sales. STAY EVEN. Yet few are promoting Yahoo's stock as a wise place to park your money. Shares are trading at $34, representing a market valuation of $46 billion. That has even sanguine analysts treating the stock with skepticism. Although Jeffries analyst Youssef Squali believes Yahoo could top expectations, he downgraded it last week from buy to hold. "We believe that the stock already reflects much of the potential upside," Squali wrote in his Oct. 11 Yahoo report. Is Yahoo still going strong? You bet. But tech investors would do well to take a lesson from Seinfeld: Don't be too cheery or too glum about this earnings season.  With Olga Kharif in Portland, Ore., and Ben Elgin and Cliff Edwards in Silicon Valley Kerstetter is a correspondent in BusinessWeek's Silicon Valley bureau
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