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No Spark for Big Blue's Stock

Investors appear to view Big Blue with jaded eyes these days. In the past week, at least two Wall Street analysts have upgraded their rating on IBM shares to outperform or buy. In fact, almost every Wall Street analyst rates the stock a buy. But investors have greeted that news with a big yawn.

IBM (IBM) shares have barely budged from between $81 and $82 in the last two weeks. For the year, its shares are down 15%, even after recovering from a low of $72, where it had sunk in April. Despite turning in solid financials for much of Chief Executive Samuel Palmisano's tenure, IBM's stock performance has lacked luster, generally hovering in the mid-$70s to low-$80s range.

What's ailing this stock? Mainly, it's the worry that IBM's transition from a hardware to a services company will hit a roadblock (see BW, 4/18/05, "Beyond Blue"). Fears were especially heightened when CFO Mark Loughridge talked about "execution issues" in services after delivering first-quarter results that fell short of both Wall Street and the company's own expectations.

STUNTED GROWTH. The services group is the source of about half of IBM's $96 billion annual revenue. At the same time, sales of mainframes -- another crucial growth area -- have been off 16% in the first quarter, 24% in the second, and 4% in the third. "Strength in mainframe sales and service bookings will be two key numbers that we will look for going forward," says Mark Stahlman, technology strategist at investment bank Caris & Co.

Palmisano has tried to rev up the growth engines at IBM. Thanks to a bunch of new contracts, IBM's services business grew 6% in the second quarter. But it inched forward only 3% in the third quarter. After the weak demand for services in Europe became clear earlier in the year, Big Blue cut 14,500 jobs in Western Europe. Counting on improving fundamentals in services, Citigroup analyst Rich Gardner raised his ratings to buy from hold on Oct. 10 (see BW Online, 10/10/05, "Citigroup Ups IBM to Buy"). "Bookings for 2005 look up 10% to 15% vs. down 22% last year," Gardner says in his report.

Investors were somewhat heartened to know that IBM had signed contracts worth $11 billion in the third quarter. In after-hours trading on Oct. 17, its stock was up $1.50, to $84, despite IBM reporting that its earnings slipped 2.5%, to $1.52 billion, and revenues fell 8%, to $21.53 billion (see BW Online, 10/18/05, "IBM's Small-Biz Engine That Could").

PEER LEADER. It's expected to get a boost from mainframes sales in the fourth quarter, thanks to its latest z9 machine launched in July. The rash of personal-data breaches at a variety of corporations ranging from banks such as Bank of America (BAC) to media companies such as Time Warner (TWX) is amplifying expectations for z9 sales, which is said to better safeguard information.

Credit Suisse First Boston analyst Andrew MuCullough said in a recent report that this latest mainframe will lead to IBM's renewed growth through 2006. He boosted the stock's rating to outperform on Oct. 11 and raised his target price to $96 (see BW Online, 10/11/05, "CSFB Ups Opinion on IBM").

Investors might also be interested in knowing that IBM's stock valuation might look pretty attractive when compared to its peers'. Sanford Bernstein Senior Analyst Toni Sacconaghi pointed out in a reasearch note that IBM stock currently trades at an 8% discount to rival Hewlett-Packard (HPQ), based on forward earnings.

STEADY RISE. But the languid movement in IBM's stock price over the last few years may be a sign that it will take more than services improvements and new mainframe sales to get investors enthused about the company. "Mainframes just don't get people excited any more," says Peter Cohan, an author and investment strategist in Marlborough, Mass. Still, IBM is a stable stock to hold in a portfolio, and it pays solid dividends -- 70 cents a share in 2004, and 58 cents a share so far this year.

IBM's financial performance has hardly been poor. Discounting the first quarter of 2005, Palmisano has managed to steadily increase sales -- 8% in 2004 and 10% in 2003. The mean analyst target for the Armonk (N.Y.) company's stock is $97. That's a nice 18% over its current price. And it's hardly an impossible goal, since the stock was at that level as recently as January, 2005. But it's just not clear what it will take to get investors jazzed about Big Blue.


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