On April 14, IBM released first quarter revenue and earnings figures that failed to meet analyst estimates and sent a shock wave through the financial markets. On Wall Street, many pundits openly wondered whether corporate IT spending is on the decline. What those pundits did not notice is that IT spending still looks healthy among small and medium-size companies in general and iSeries customers in particular.
The worries began to mount when IBM announced that it had realized earnings of $1.41 billion--or 85 cents a share--on revenues of $22.9 billion during its first quarter. This fell significantly short of analyst estimates for earnings of 90 cents a share on revenue estimates that ranged from $23.2 billion to $23.8 billion. Including the effect of favorable currency changes, IBM's revenue and profits both grew by only 3% over the first quarter of 2004.
One thing that frightened Wall Street was the way in which IBM fell short of its estimates. During January and February, growth in orders and revenues was fairly strong. In the second half of March, however, the computer giant hit a brick wall in its efforts to close sales opportunities. Admittedly, much of the slowdown emanated from four countries--France, Germany, Italy, and Japan--that jointly account for 25% of IBM's revenues. However, the news led many industry observers to speculate whether these countries are early indicators of a broader slowdown in worldwide IT spending.
Are corporations about to put a worldwide lid on IT spending? My answer is a qualified "no" because growth persists in other parts of the market. As IBM readily pointed out, for instance, revenues from China, Russia, India, and Brazil grew 18% during the first quarter to $1 billion. In addition, orders from Eastern Europe and the Americas held steady. As such, it is likely that the slowdowns in Western Europe and Japan are more a reflection of problems that are unique to these regions. One of those problems is a planned restructuring by IBM of its European operations that could involve layoffs and office closings. As IBM admitted to Wall Street analysts, preparations for the restructuring had a disruptive effect on efforts to close European sales at the end of the first quarter.
Just as importantly, orders from small and medium-size businesses as well as iSeries customers remained strong throughout the quarter. On a worldwide basis, IBM's sales to the SMB market grew by 7% during the first quarter, making it the fastest growing industry segment for the company. The company also reported a more modest growth rate of 1% for the iSeries. However, sources within IBM are telling me that revenues actually grew 3% when orders for iSeries-specific software are included. The same sources claim that seven IBM sales regions experienced double-digit growth in iSeries revenues during the first quarter. This is encouraging news for the iSeries Division, which has set a goal of achieving double-digit growth for worldwide sales in 2005.
As these figures indicate, it does not appear that companies in most countries--or SMB firms for that matter--are slamming on the IT spending brakes. However, there is still a chance that IBM and other IT vendors will hit a few bumps in the sales road over the next several quarters. Studies by market research firms indicate that while spending on PCs will not decline, the rate of spending growth will shrink in 2005. This is to be expected now that most companies have made the transition to Windows XP workstations and Microsoft's Longhorn version of Windows is well over a year away. In addition, mainframe spending may stagnate for a few quarters because many companies upgraded their host systems last year. Indeed, sales of IBM's mainframe zSeries fell by 16% during the first quarter after experiencing a stellar 2004.
Because sales of PCs and mainframes stimulate sales of software and services, some IT vendors may find it harder to close sales in these two areas as well. Indeed, IBM experienced problems closing new short-term service contracts during the quarter. However, the company experienced rapid growth in demand for Business Process Transformation Services. This is a critical area for IBM, as it is a spearhead for the company's drive to be the leader in helping companies become On Demand businesses.
In short, IBM and other vendors may hit soft patches in IT spending for some products and services in some countries over the next few quarters. Overall, however, sales in most areas should hold steady, leading to solid if not spectacular growth. Much of that growth will come from developing economies and from SMB firms. These are market segments where the iSeries has opportunities to shine. As such, I expect that any moderation in spending growth will have a minor effect on IBM's premier midrange platform. This means that while the iSeries Division's goal of double-digit revenue growth for 2005 will be tough to achieve, it is still within reach.