Tech earnings growth running out of steam

BOSTON (Reuters) - U.S. technology companies have posted stronger quarterly profit growth than any sector except for oil, but investors fear that cracks are emerging as clients in troubled industries like finance, retail and construction reduce IT spending.

This week, business software maker VMware Inc (VMW.N) issued a revenue warning, and Cisco Systems Inc (CSCO.O) CEO John Chambers said many of his customers see the economy picking up early next year rather than later this year.

Wall Street is bracing for more bad news over the next few weeks as tech companies release earnings forecasts with their second-quarter reports.

"We're definitely concerned about the September quarter and how we are going to finish the year," said Rich Parower, managing director at J&W Seligman, which has about $4 billion in technology stocks.

"The economy has only gotten tougher," the fund manager said, adding that he expects a rash of third-quarter forecasts to fall short of analysts' estimates.

The tech earnings season starts in earnest next week, with Intel Corp (INTC.O), IBM (IBM.N), Microsoft Corp (MSFT.O) and Google Inc (GOOG.O) among the companies reporting results.

Analysts on average are looking for quarterly profit growth of about 47 percent from Microsoft, 39 percent from Intel, 35 percent from Google, and 14 percent from IBM, according to Reuters Estimates.

Overall, the 71 tech companies in the S&P 500 Index .SPX are forecast by Wall Street to report an average of 16 percent year-on-year profit growth for the second quarter, according to Thomson Reuters Proprietary Research.

While that is strong compared to expectations for an average profit decline of 13 percent for all companies in the S&P 500, estimates have come down from April, when analysts were looking for tech profit growth of 18 percent.

For the third quarter, analysts on average expect tech profit growth to slow to 11 percent, according to Thomson Reuters Proprietary Research.

LAGGING INDICATOR

Analysts say that the days of technology companies outperforming the rest of the market are coming to an end.

Tech tends to be a lagging indicator as businesses do not cut spending on software, computers and other tech products at the beginning of a recession -- since these investments can help boost efficiency or cut costs.

But when times get tough, even the most prized projects get delayed or scrapped, analysts said.

One example of a company whose products are coveted by IT managers is VMware, whose software helps businesses reduce the number of computers they need in data centers, cutting costs for maintenance, electricity and hardware.

"VMware was seen as recession proof" before this week's revenue warning, said 451 Group analyst Rachel Chalmers. "It is not."

That message resonates with Kevin Landis, chief investment officer for Firsthand Funds. "There is no reason not to be cautious right now," he said.

Goldman Sachs this week forecast 5 percent growth in IT spending this year, slowing from 7 percent in 2007. Areas of weakness include tech services, hardware and network equipment, with companies at risk including Computer Sciences Corp (CSC.N) and Accenture Ltd (ACN.N), Goldman said.

Goldman said businesses will demand steeper discounts on tech products as the economy weakens. Large companies with economies of scale are best equipped to weather that, Goldman said, citing Cisco, Hewlett-Packard Co (HPQ.N), IBM and Oracle Corp (ORCL.O) as beneficiaries.

But the slowdown in growth is still affecting the big companies like Oracle, the world's No. 3 software maker after Microsoft and IBM.

Last month, in what may be a precursor for how the earnings season plays out, Oracle reported better-than-expected profits for its fiscal quarter that ended in May, but issued a forecast that called for growth to slow in the current quarter.

That outlook disappointed investors, pushing down shares of Oracle as well as the broader stock market.

"I think you'll find that Oracle foreshadows what is likely to occur," said Arnie Berman, chief technology strategist for Cowen & Co.