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By Jeremy Glaser and Grady Burkett, CFA | 10-29-2012 10:00 AM

Disappointing Earnings No Reason to Shun Tech

Cyclical and economic concerns have hampered the tech sector but are also creating potential buying opportunities in large- and mid-cap names, according to Morningstar's Grady Burkett.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We are in the midst of tech earnings season, and we've had some misses that have raised concerns about both the enterprise and the consumer. I am here with Grady Burkett. He is the director of technology research at Morningstar, and we're going to get his take on these questions.

Grady, thanks for joining me today.

Grady Burkett: Thanks for having me, Jeremy.

Glaser: So, IBM kicked off earnings season on somewhat of a down note saying that they saw enterprise customers looking a little bit weaker than they had expected. Is that a trend you've seen throughout the tech earnings season, and what do you think is happening there?

Burkett: We have heard this commentary, this short-term commentary, around some uncertainty in enterprise budgets from other firms within the technology sector. So, there is certainly some credibility around what IBM is saying. We have this fiscal cliff that's emerging. We have some uncertainty around maybe what's going to happen in the fourth quarter. Normally, you'd expect to see a bit of a budget flush, maybe that doesn't come through in the fourth quarter for some of these vendors.

With IBM, specifically, you also had a couple of firm-specific issues at work. They are at the very front end of a mainframe product-refresh cycle, and they only ship the mainframe for 30 days out of the quarter. So, there is a sort of this trough phenomenon going there. You also have currency headwinds, and so they did cite that currency played a role about a 3-point roll in their 5% year-over-year decline in revenue.

Finally, in our view, there are some questions around the long-term secular trends in software. So, IBM has a very large software application consulting business and a very large software middleware business that supports traditional software enterprise applications. And as we move to kind of cloud-based applications like Workday for human resources or Salesforce.com for sales automation, that's when you might see some long-term pressure on IBM’s software business. They have to do some things, make some changes in the portfolio.

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