IBM feels the love
Big Blue's stock has soared in the past month. Is there more upside ahead?
November 13, 2002: 5:15 PM EST
By Paul R. La Monica, CNN/Money Staff Writer
NEW YORK (CNN/Money) - Big Blue has enjoyed a big bounce lately.
After falling as low as $54 in early October, shares of IBM are now back around the $80 level, a gain of nearly 50 percent in a little more than a month. It seems safe to say that investors have gotten used to an IBM without Lou Gerstner at the helm.
It was a rough beginning for new CEO Samuel Palmisano, who took over in March and will replace Gerstner as chairman in January. IBM's stock tanked during the summer along with the rest of the tech sector. But Big Blue has surged during the past month along with the rest of the sector.
In fact, it has outperformed the Nasdaq in the past month thanks in large part to bullish comments Palmisano made at the end of October. Palmisano said he thought the economy was "flattening out." Another reason the stock has soared is because it is perceived as a safer tech sector play.
There was also good news from IBM chief financial officer John Joyce during a conference call with analysts on Wednesday. Joyce said that Wall Street's revenue and earnings targets for 2003 were "reasonable." Analysts expect revenue of $87 billion, which would be an increase of 7.8 percent from current estimates for 2002 and earnings of $4.31 a share, which would be a gain of 10.2 percent.
Joyce also confirmed reports that IBM was in talks with J.P. Morgan Chase about a $5 billion outsourcing contract. According to the reports, IBM would manage a majority of the bank's global computing operations for a period of seven years.
If IBM lands this deal it would be a huge victory for the company, says Adam Adelman, an analyst with money management firm Philippe Investment Management. Adelman says that other large financial institutions might also look to IBM for outsourcing contracts, especially since IBM rival EDS is struggling.
"Potential customers have more faith and confidence in the financial health of IBM," Adelman says. Philippe owns shares of IBM in its funds.
More contract wins needed
Consulting services has become the biggest division for IBM. Investors have applauded IBM's success in consulting because the business is more predictable than selling hardware and software as revenues tend to be recurring. In the third quarter, 45 percent of IBM's total sales came from its global services division. And that percentage is likely to increase since IBM finalized its purchase of PricewaterhouseCooper's consulting division in October.
Another encouraging sign, says Andrew Pratt, manager of the Montgomery U.S. Focus and Montgomery Growth funds, is that IBM intends to spend $700 to $800 million in advertising in the next 12 months, more than double last year's promotional budget. Several of the ads will focus on IBM's consulting services, including the newly acquired PwC division. Pratt thinks this should help the company gain more market share even if the economy remains weak. Pratt owns IBM in both of his funds.
But have investors gone overboard with their enthusiasm?
Concerns about IBM's pension fund contributions haven't gone away yet. Several large companies have been forced to contribute more money to pensions than they had planned because of the bear market. Adelman estimates that unless there is a major market recovery, IBM might be forced to contribute as much as $2 billion to the pension fund by 2004. That would take a significant bite out of earnings.
And even though IBM is certainly among the more stable technology companies out there, the stock's recent run-up reflects that somewhat. IBM is now trading at 18.5 times 2003 earnings estimates even though earnings are expected to increase just 10 percent next year and at about an 11 percent rate for the next three to five years.
To be sure, Pratt says that earnings estimates would probably increase if IBM does announce more big outsourcing contract wins. But until that happens, he says he wouldn't be buying more of the stock.
"I'd probably press my bet when there are signs that things are getting better. I don't necessarily see that now," Pratt says.