What Is The Connection Between The Pending Recession and Q4 2007 Earnings Results?

My previous post on the impending US recession, the falling dollar and its impact on start ups was still fresh in my mind, when this report on IBM from my good friend Andy Neff at Bear Stearns came through my email (I italicize below form emphasis in point 1).

IBM Corporation IBM–$101.10–Outperform

Should Someone Tell IBM’s Customers About The Pending Recession? Strong 4Q07 Results And Optimistic Outlook For 2008; Raising Ests And Target To $118

· STRONG QTR, OUTLOOK. While we’re not oblivious to potential global macro weakness, it seems that IBM’s customers may be, as the company delivered an impressive quarter w/o any red flags (i.e., weakness in short-term signings or elevated IP levels) and provided a favorable ‘08 outlook of 15-16% EPS growth. We’re raising ests back to levels before our 1/14 cut and our CY08 target to $118.

· OPTIMISTIC TONE. Similar to JAVA’s comments, while all companies will be impacted if a recession scenario unfolds, IBM continues to execute well as it benefits from a diverse product portfolio, balanced geographic mix (65% of revs outside US), strong annuity stream (e.g., software maintenance, services signings), and improved productivity from restructuring actions. Despite $0.50 EPS benefit from pension savings in ‘08, IBM also has the tailwind of solid services momentum and new hardware platforms (zSeries in Feb, rollout of Power6 in pSeries).

· IMPRESSIVE 4Q07. IBM reported 4Q07 EPS of $2.80, in line w/ its pre-announcement and well above our $2.62 est. (Street at $2.68), driven by stronger revs and better GM (despite weakness in Services GM) and partially offset by higher opex and lower int. income. Revs of $28.9bn (up 10% YoY) were driven by strength in Services (up 17% YoY) and non-US markets (up 15% YoY). Services signings of $15.4bn were above $14-15bn expectations given short-term signings strength (up 8% YoY).

· RAISING ESTS. Given strong execution and progress on IBM’s long-term goal of 2010 EPS at $11 (or ~15% avg EPS growth over the next 3 yrs), we’re raising EPS for '08 from $7.95 to $8.30 and for ’09 from $9.00 to $9.40.

· RAISING CY08 TARGET. Based on our analysis which compares IBM to its mega-cap peers, we believe IBM’s improved consistency and stronger 3-yr growth profile should warrant parity w/ the peer group on P/E basis, which should translate to further valuation upside. We’re raising our CY08 target from $113 to $118 using a 12.5x P/E on ‘09 EPS.

In my view the strong Q4 is actually a sign the recession is coming. (even though the Talmud says that prophecy in this generation was given to fools, I will venture in here) IN fact, I think many enterprise companies will have strong Q4s heading into the recession. Why? Because IT people know the budgets will tighten in 08 as the recession bites. Wall Street IT departments are getting ready for the slashing the will come when the subprime mess filters down to their departments' budgets. So, in Q4 they grabbed every extra dollar in the budget for their IT projects before the someone turns off the hose.