Market Share: Public and private, things look better for everyone

Bill Loomis

With the second-quarter earnings season over, investors seem more confident that commercial information technology spending has bottomed out and is improving. Several Wall Street firms have upgraded technology companies in recent weeks, which helped shares, including commercial IT service firms, hit new 52-week stock price highs.

Once again, the stock market is jumping ahead of results, as most publicly traded commercial IT service firms are still reporting negative organic growth (growth excluding acquisitions).

While most commercial firms met expectations in the second quarter, one did not. BearingPoint Inc. reported fiscal fourth quarter earnings per share of 4 cents vs. break-even a year ago, well below company guidance of 14 to 17 cents.

Revenue in the quarter was $774.8 million, up 33 percent year-over-year, but well below the company's guidance of $800 million to $860 million. Revenue was impacted by an unanticipated shortfall in Europe of about $40 million, as well as a postponement and a cancellation from a restaurant firm and a retail firm, costing $15 million to $20 million.

However, BearingPoint's public-services unit was a solid performer. Revenue climbed 11 percent year-over-year. The company's federal government unit was especially strong, up about 21 percent by our calculation. The federal business continues to be a sizable -- about 25 percent of revenue in fiscal 2003. State and local work, about 23 percent of public-services revenue, was down only 2 percent year-over-year and was up 11 percent quarter-over-quarter.

Despite the disappointing surprise from BearingPoint and its 23 percent stock sell off that day, its leading competitor, Accenture Ltd., hit a new 52-week high the same day.

Clearly, investors believe 2004 will be good for commercial IT spending. I also believe there will be improvement in 2004, though the turn likely will be slower than most investors expect. With no external catalyst, such as Y2K, e-business or new "must have" technologies, IT spending will be a function of business growth, which seems to be showing gradual improvement.

Earlier this year, we saw a bounce in commercial technology names at the expense of the federal IT service stocks, which had a sharp sell off in the first four months. This time, however, both groups are doing very well, with several public federal firms' stocks hitting 52-week highs.

Federal IT firms generally reported solid second-quarter fiscal 2003 results, and most believe contract award activity will pick up in the next couple quarters, thus exciting investors.

A rise in one IT segment doesn't have to be at the expense of another if fundamentals are strong or improving in both, and there is sufficient capital flowing into stocks. The publicly traded federal IT service stocks we track are trading at 23 times consensus 2004 earnings-per-share estimates, a healthy price-to-earnings ratio compared to the S&P 500 price-to-earnings ratio of 18 times on consensus 2004 earnings.

While the commercial IT service firms may likely see earnings-per-share and price-to-earnings ratio expansion in the next few years as demand improves in its business, the federal IT service firms probably will have to depend more on earnings growth alone to improve its share prices given its well-above market price-to-earnings ratio. *

Bill Loomis is a managing director of the Technology Research Group at Legg Mason Wood Walker Inc. He can be reached at wrloomis@leggmason.com. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. For additional information and current disclosures for the companies discussed herein, please write to: Legg Mason Wood Walker Inc., 100 Light St., P.O. Box 1476, Baltimore, MD 21203, Attn: Research Department.

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