IBM Corp (IBM.N) reports earnings after the bell on Tuesday and investors are hoping strong software demand will make for a repeat of last year's first-quarter performance, when the company raised its full year forecast.
After Oracle Corp's ORCL.O strong first-quarter software sales and outsourcing firm Accenture Plc's (ACN.N) positive outlook on IT spending, there is a chance that IBM - which competes with both companies - may raise its full year outlook. Sterne Agee analyst Shaw Wu wrote in a recent note that there was a "fair likelihood" IBM would "modestly raise" its outlook.
Software represents IBM's most important division and biggest growth driver and includes everything from data analytics that help forecast and fight crime to software that manages infrastructure.
IBM, which dumped its PC business in 2004 to concentrate on consulting and services, has squarely focused on software as a means to provide the foundation for its growth strategy. The company proved that once again on Monday, with the Nikkei business daily reporting it sold its point-of-sale (POS) terminal business, which includes cash registers and related devices, to Toshiba Corp (6502.T) for 70 billion yen ($870.86 million).
IBM declined to comment.
IBM's software business generated 44 percent of its pre-tax profit last year and the company has said it will contribute 50 percent to its segment profit by 2015.
IBM has said it expects to reach an operating EPS of at least $14.85 this year compared with analysts' forecasts of $14.94, according to Thomson Reuters I/B/E/S. In the first quarter, analysts expect IBM to post an operating EPS of $2.65 and sales of $24.8 billion.
The thinking behind IBM's strategy is that specialized software is of higher value and will result in higher margins, keeping IBM firmly on track to reach its earnings per share goal of $20 by 2015.
Sterne Agee's Wu agrees, saying IBM's strategy of marrying IT with software and services "has given it strategic and structural advantages."
Improving demand for branded middleware - a software that facilitates integration of applications or end devices and servers - and continued momentum in analytics could make software the stand-out division this quarter and this year for IBM, according to Goldman Sachs.
IBM competes with business software makers Oracle Corp and SAP AG (SAPG.DE) as well as Hewlett Packard Co (HPQ.N).
IBM's services business, its second-largest unit, is expected to be stable given rival Accenture's strong quarter and optimistic outlook. That is good news for investors considering that outsourcing competitors Infosys Ltd (INFY.NS) and Cognizant Technology Solutions Corp (CTSH.O) had warned that customers were spending less.
The services unit incorporates PriceWaterhouseCoopers consulting business, which IBM bought in 2002. It generated 42 percent of the company's pre-tax profit in 2011.
IBM's smallest division, its mainframe business, is expected to continue to show declining revenue in the first half of 2012. But rising demand for storage should boost the business near-term, Goldman Sachs said.
"We believe a new mainframe cycle and remarkably easy comparisons could produce healthy revenue and profit growth in the second half," Goldman Sachs said.
Stifel Nicolaus' David Grossman said IBM may even be taking server business away from HP and Oracle.
"In hardware, HP and Oracle posted weak January and February quarters, respectively, which we believe at least partially reflects competitive displacements by IBM," Grossman said, adding that IBM would likely benefit from an ongoing infrastructure build-out in emerging markets.
IBM trades at 13.2 times estimated 12 month forward earnings, according to StarMine, which gives more weight to timelier forecasts and those from the historically most accurate analysts. By comparison, Oracle and HP are valued at 10.9 and 5.8, respectively.
As it has done historically, IBM's Chief Financial Officer Mark Loughridge will run the company's earnings call and not new Chief Executive Virginia Rometty, who made headlines last week for attending the Masters golf tournament, hosted by the Augusta National Golf Club - a men's only club.
IBM is one of the sponsors of the tournament and its CEOs have traditionally been granted membership to the exclusive club, but so far Augusta chairman Billy Payne has refused to say whether it would change its policy for Rometty.
(Reporting By Nicola Leske; editing by Peter Lauria and Andre Grenon)