You Too, Big Blue?

After disappointing results from some of the biggest names in tech, some investors are curbing their enthusiasm for IBM's numbers

The weather may be heating up, but earnings at some of the tech industry's titans are doing anything but that. During the second week of July, the culprits were EMC (EMC) and SAP (SAP), which both had negative surprises for investors.

Data-storage equipment maker EMC on July 14 sliced forecasts for the current year, days after saying second-quarter results fell short of its expectations. For 2006, EMC now expects per-share earnings of 51 cents on sales of $10.8 billion, after earlier projecting earnings as high as 57 cents on as much as $11.3 billion in revenue. Germany's SAP on July 13 reported software license sales of €621 million ($785 million), far short of the €680 million ($860 million) analysts expected. It was a rare miss for the business-management software giant.

Now, some investors fret IBM (IBM) may be the next letdown when it reports second-quarter results on July 18. Analysts such as Benjamin Reitzes of USB say the quarter may not be as good as previously expected, mainly due to some pretty bearish macro trends—rising oil prices and slowing economic growth, to name just a couple. He and other analysts have been concerned about a dearth of big contracts announced by IBM of late. Big Blue is expected to earn $1.29 a share on $21.88 billion in revenue, vs. $1.12 per share on $22.3 billion in sales a year earlier.


 It's not that analysts are expecting a disastrous quarter for IBM, just nothing to get excited about in a tech market trapped in a bad case of summer doldrums (see, 7/13/06, "Why Dell, Apple Declined"). Analysts who are lowering their numbers aren't doing it by much: Reitzes says earnings per share will be a penny less than he expected at $1.29; analysts at JPMorgan lowered sales forecasts by a hair.

Business often slows during the second calendar quarter for both hardware and software companies before heating up in the second half. But this year, the usual slowdown is being exacerbated by such matters as $77-a-barrel oil and fears of inflation. Against that backdrop, companies in the U.S. and Europe are less inclined to embark on new, pricey software or hardware upgrades. "As long as macro overhangs such as inflation fears, oil price concerns, and a weaker recovery in Europe remain, it is unlikely that the sector will see significant appreciation," Goldman Sachs said of software in a July 13 research note.

There's little consensus on how quickly the tech sector will bounce back in the second half. Jason Maynard of Credit Suisse is optimistic about software, at least. He's picked up on a lot of caution among corporate buyers surveyed in recent weeks, but says IT projects can't be put off forever. Then there's also the possibility of using other means to get a company's stock moving: acquisitions, dividends, and share repurchases.


  Events like those aside, investors just aren't seeing a lot of catalysts for share rallies. In the case of EMC, hot divisions such as Documentum, which focuses on content management software, are going gangbusters. But overall, the company has developed a reputation for inconsistent results, analysts say. Chief Executive Joe Tucci conceded as much in the company's July 14 conference call, saying: "We never know what customers are going to order. I absolutely believe this issue was a self-induced execution failure on our part." Honest? Yes. Encouraging to shareholders? Hardly. The stock is trading at the lowest level since 2004. It closed on July 14 at $9.83, down 1.5%.

SAP has something of the opposite problem. It may be too well liked on Wall Street. The stock is expensive, trading at 21 times projected earnings for 2007, compared with peers that trade at just 16 times the same measure, according to JMP Securities. The company's disappointing July 13 figures led to a 6% decline in the stock. Unlike EMC, SAP sees its results as a small setback, saying it still expects to increase software revenues by 15% to 17% for the year. Pat Walravens, an analyst at JMP Securities, is skeptical. SAP would have to increase software revenues by 8% in the third quarter and 43% in the fourth quarter to hit that target. He expects just 12% growth in the fourth quarter. With that kind of uncertainty over its numbers, there's little reason to overpay.

In the wake of all of this, investors may turn to smaller companies in growth markets to get them through the dog days of summer. While the big names struggle, on-demand software companies, which deliver software over the Internet for a monthly fee, continue to do well. Walravens notes that revenues from on-demand companies he covers, including (CRM) and RightNow Technologies (RNOW), have experienced double-digit growth recently.

There may yet be bright spots in tech. Investors just have to look a little harder through the summer haze to find them.

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