October 15, 2010 / 10:15 PM / 7 years ago

IBM 3rd-quarter seen strong, helped by new mainframe

5 Min Read

NEW YORK (Reuters) - A new mainframe computer and a recovery in global tech spending likely buoyed International Business Machines Corp's third quarter, giving its shares room to rise.

The shares climbed to record levels this week, but a stronger outlook, particularly in IT services, could nudge them even higher, analysts and investors said.

"The shares have risen quite a bit lately. But I still view it as a very solid, long-term story because they have strong growth in services, software and hardware," said Standard & Poor's analyst Thomas Smith.

Over the past decade, IBM has shifted its focus to profitable software and IT services, away from low-margin computer hardware. Its increasing profitability has been a major attraction for investors.

But for the third quarter, analysts said they will be focusing on how customers responded to new hardware products, including a new "System z" mainframe computer able to process vast amounts of data and financial transactions.

"Hardware has recently gone to less than 20 percent of revenue, so people begin to ignore that. However, in this quarter, one thing I'm looking for is how the launch goes with new hardware products," said Smith, adding that servers and other hardware products were crucial as they often spur sales of IBM's services and software.

He rates IBM a "strong buy", the highest recommendation in his rating system. Smith does not own shares of IBM.

Wall Street expects third-quarter earnings of $2.75 per share for the third quarter, up from $2.40 per share a year earlier, according to Thomson Reuters I/B/E/S.

Quarterly revenue is expected to grow 2.4 percent to $24.1 billion, compared with a year ago.

Services Growth

The results, due on Monday, are likely to show solid growth in software and services as well, analysts said.

Results from technology services companies like Accenture Plc and Infosys Technologies Ltd have been strong, as more companies invested in IT projects after holding back during the global economic downturn.

Analysts and investors said an increase in services contracts, which would indicate even stronger revenue growth ahead, was a key condition for the shares to rise further. One good sign, some of them said, was a recent extension in IBM's technology services contract with ABN AMRO.

"If there's been one thing that's been holding back IBM shares, it's that their services signings have been disappointing. So this quarter, investors are hoping services signings will bounce back," said Mark Demos, a portfolio manager at Fifth Third Asset Management, which owns IBM shares.

A strong outlook for the services and software segment could prompt IBM to raise its outlook for the full year. It previously forecast annual earnings of "at least $11.25".

IBM shares marked a record high of $142 before closing at $141.06 on Friday. They have risen only around 8 percent in the past 3 months.

Analysts said there was still room for growth, particularly since IBM said in May that it expects to double its profit by 2015.

Valuations also suggest they are still trading at a discount to other technology companies. Even with the recent gains, it is trading at 12.5 times earnings, compared with multiples of around 15 for Accenture and 14 for software rival Oracle.

For a comparison of valuations with Accenture and other competitors, please click: link.reuters.com/hyh78p

While few analysts and investors see IBM as a strong growth stock due to its size, many have said that Chief Executive Sam Palmisano's leadership in delivering solid earnings growth made it an attractive bet, particularly as rivals have been distracted by various issues.

Hewlett-Packard Co only recently appointed a new CEO following the scandalous departure of Mark Hurd, and has worried some investors by engaging in a bidding war with Dell Inc for storage company 3PAR.

IBM has also been stepping up acquisitions to compete with HP and Oracle, aiming to become a "one stop shop" for all of their customers' technology needs. But, to investors' relief, it has so far avoided splashy deals.

The company is likely to disclose on Monday how much it has spent on acquisitions during the past quarter, and analysts said they do not expect it to be a worry.

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