A month has gone by since the last earnings report for IBM (IBM). Shares have lost about 0.2% in that time frame, underperforming the S&P 500.
Will the recent negative trend continue leading up to its next earnings release, or is IBM due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.
IBM Surpasses Q3 Earnings, Revenues Miss Estimates
IBM reported third-quarter 2019 non-GAAP earnings of $2.68 per share, which surpassed the Zacks Consensus Estimate of $2.64. However, the bottom line fell 22% on a year-over-year basis.
Revenues of $18.03 billion missed the Zacks Consensus Estimate of $18.24 billion and declined 3.9% on a year-over-year basis. At constant currency (cc), the top line fell 0.6%. The year-over-year revenue decline can primarily be attributed to currency fluctuation and headwinds from IBM Z product cycle.
Notably, IBM stated that signings improved 15% in the third quarter to over $9 billion. However, services backlog fell 2% year over year and amounted to $107.6 billion.
Red Hat Acquisition
IBM has completed the acquisition of Red Hat on Jul 9, 2019, for $34 billion in cash. The deal is part of the company’s efforts to bolster Open Hybrid Architecture Initiative.
Revenues from Red Hat improved 19% (up 20% at cc) on normalized basis.
The deal marks IBM’s largest acquisition ever and the combined company is likely to alter the dynamics of “the cloud market for business.” Specifically, IBM intends to leverage Red Hat to help it become the world’s largest hybrid cloud platform provider.
Following the buyout, Red Hat will join IBM's Cloud and Cognitive Software segment and will function as a separate entity.
Geographic Revenue Details
Revenues from Americas decreased 1% on cc basis and came in at $8.5 billion. Meanwhile, revenues from Europe, Middle-East and Africa were $5.5 billion, flat year over year. The same from Asia-Pacific declined 1% on a year-over-year basis and came in at $4 billion.
Starting from first-quarter 2019, IBM combined Cloud business and Cognitive Software into one segment. Further, the company merged security services with security software.
IBM also integrated all divested business to the other categories in order to provide enhanced transparency to the software and GBS segments. The divested business includes pending sales of seven software products to HCL, the sale of IBM’s marketing platform and commerce software offerings to Centerbridge, and the recently concluded sale of Seterus mortgage servicing business.
Cloud & Cognitive Software Segment
The Cloud & Cognitive Software segment’s revenues-external improved 8% year over year (on cc basis) to $5.3 billion. Revenues at Cloud & Cognitive Software (including cloud and data platform, Red Hat Cognitive application and transaction processing) increased primarily due to growth in application driven by security and solutions, improvement in data and analytics, synergies from Red Hat acquisition and growth across hybrid cloud and data portfolio.
Segmental revenues pertaining to Cloud surged 63%.
Revenues from cloud and data platforms increased 19% year over year.
IBM’s attempt to bolster hybrid cloud business with Red Hat Acquisition is likely to bolster the company’s prospects.
Notably, IBM witnessed growth in industry verticals like health, key areas of analytics and security in the reported quarter. Watson Health witnessed broad-based growth in Payer, Provider, Imaging and Life Sciences domains.
Revenues from Cognitive Applications were up 6% year over year, driven by security, software, health, supply chain and weather. Security growth was backed by offerings in orchestration, data security and endpoint management.
Further, robust sales of Resilient and QRadar, which address areas like endpoint protection, incident response and security intelligence, were other positives.
Transaction Processing Software revenuers, which includes software that runs mission-critical workloads, were down 4% year-over-year basis.
Global Business Services Segment
Revenues from Global Business Services-external segment totaled $4.1 billion, up 2% from the year-ago quarter. The year-over-year increase in the top line can primarily be attributed to growth across all three business areas namely consulting, application management and global process services.
Cloud revenues surged 10% year over year.
Application Management revenues were flat year over year. Global Process Services revenues declined 3%. Moreover, Consulting revenues increased 5% year over year on solid performance of IBM’s digital business.
Global Technology Services Segment
Revenues from Technology Services-external decreased 4% from the year-ago quarter to $6.7 billion. Segmental revenues pertaining to cloud advanced 10% from the prior-year quarter.
Infrastructure & Cloud Services’ revenues decreased 4% from the year-ago quarter. Moreover, Technical Support Services revenues declined 3% from the year-ago quarter.
Systems revenues decreased 14% on a year-over-year basis to $1.5 billion, primarily owing to the decline in the IBM Z product cycle and storage. Segmental revenues pertaining to Cloud revenues declined 19%.
IBM Z revenues decreased 20% year over year.
In September this year, the company announced its latest advanced mainframe, z15. The new z15 can support private and public clouds via Linux. With this specification, the company believes that the new mainframe will find widespread acceptance in the financial, government, retail, and travel and transport industries, where the number of transactions is much higher and data security is of prime importance.
However, Power revenues decreased 27% from the year-ago quarter.
Meanwhile, storage hardware revenues also declined 4% year over year on weak performance in both high-end and mid-range, and stiff competition. IBM stated that pricing pressure in the immensely competitive storage market is hurting revenues.
While Operating Systems Software revenues decreased 7%, Systems Hardware slumped 16% from the year-ago quarter.
Finally, Global Financing (includes financing and used equipment sales) revenues decreased 11.7% year over year and 10.7% at cc to $343 million.
Non-GAAP gross margin were flat year over year and came in at 47.4%. The gross margin benefited primarily expansion in services margin and shift to high value, services productivity and cloud scale efficiencies.
Non-GAAP operating expense (research & development expenses and selling, general and administration expenses) declined 16% year over year. On a GAAP basis operating expenses increased year over year on Red Hat acquisition synergies and improving operational efficiencies. Currently, IBM continues to invest in rapidly growing fields like hybrid cloud, AI, security and blockchain.
Pre-tax margin from continuing operations contracted 590 bps on a year-over-year basis to 13.3%.
Balance Sheet & Cash Flow Details
IBM ended third-quarter 2019 with $10.82 billion in total cash and marketable securities compared with $45.4billion in the previous quarter. Total debt (including current portion) was $66.3 billion (which includes $23.1 billion from Global Financing debt), down from $73 million from the previous quarter.
The company reported cash flow from operations (excluding Global Financing receivables) of $3.6 billion and generated free cash flow of $1.8 billion in the quarter under review.
Moreover, the company returned $1.6 billion to its shareholders through dividends and share repurchases. However, the company suspended its share repurchase program on Jul 9, post Red Hat acquisition.
For 2019, IBM now expects non-GAAP EPS to be at least $12.8.
IBM still anticipates 2019 free cash flow of $12 billion.
How Have Estimates Been Moving Since Then?
In the past month, investors have witnessed a downward trend in fresh estimates.
At this time, IBM has an average Growth Score of C, a grade with the same score on the momentum front. However, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.
Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.
Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, IBM has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
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