UPDATED 16:37 EDT / OCTOBER 17 2016

NEWS

IBM revenues fall again, but turnaround looks closer than ever

Beating analysts’ estimates on earnings-per-share and revenues in its third quarter, IBM Corp. today provided evidence that it may be turning the corner on its ongoing transformation into what it calls a “cognitive solutions and cloud platform company.”

Quarterly earnings per share of $3.29 beat consensus estimates of $3.23. Revenue from continuing operations was $19.2 billion, about 1 percent ahead of consensus estimates of $19 billion. Perhaps more importantly, revenues nearly equaled the $19.28 billion recorded in the same quarter last year. Although IBM suffered its 18th consecutive quarterly revenue decline, the year-over-year drop of less than one-half of 1 percent is the smallest recorded during that streak.

Expense increases of 2 percent drove overall operating profits down by 8 percent and gross margins fell nearly across the board. IBM said it has invested aggressively in capital expenditures, research and development and acquisitions to the tune of $12 billion so far this year while returning $6 billion to shareholders through dividends and stock buybacks.

“What you see in our results is stability and continued strong growth in our strategic imperatives,” said Martin Schroeter, IBM senior vice president and chief financial officer. “Our balance sheet continues to be is well-positioned to support our business over the long term.”

Investors were apparently underwhelmed by the news, however. In after-hours trading, they initially pushed IBM stock down by about 1 percent. Investors may been disappointed by IBM’s decision not to change its previous full-year earnings guidance of $13.50 per share, a target it described as conservative in its second-quarter earnings call. The company did say free cash flow is likely to exceed earlier expectations, however.

Financial analysts were split on the near-term outlook. Barclays PLC cut its price target modestly from $140 to $135 per share, citing weaker operating margins. Morgan Stanley also cut its price target slightly, but to a more bullish goal of $179. The investment firm said it expects earnings growth to accelerate in 2017.

‘Strategic imperatives’ now 40% of the business

IBM said revenues from what it calls “strategic imperatives” – cloud, analytics, mobile, security and “engagement” technologies like collaboration and social media – rose 16 percent over the previous year’s quarter, with cloud revenues rising 30 percent to $6.7 billion in the quarter and $12.7 billion for the trailing four quarters. The 16 percent growth in strategic revenues is ahead of the 12 percent increase the company reported in the second quarter, and those technology areas crossed the psychologically important threshold of 40 percent of overall revenue, up from 38 percent the previous quarter.

“The imperatives showed particularly strong growth, although still not enough to fully cover declines in the legacy business,” said Rob Enderle, chief analyst at Enderle Group Inc. But he added that, at 40 percent of revenues, strategic imperatives will soon reach the crossover point. “IBM should be in a position for sustained growth within 12 months,” Enderle said.

Analytics revenue was up five percent overall but 14 percent in strategic imperatives, a trend that Schroeter attributed mostly to Watson. IBM now has more than 7,000 employees in its Watson health business alone, Schroeter said. Mobile revenues grew 43 percent and security edged up 18 percent.

Although the company’s cloud revenues are growing smartly, it’s struggling to keep up with infrastructure-as-a-service giants like Amazon Web Services and Microsoft Azure. IBM has put its chips on hybrid clouds, as have most of its legacy infrastructure peers. Last week’s landmark deal between Amazon and VMware Inc. won’t help, however. While IBM and VMware have a partnership of their own, Amazon’s embrace significantly improves its hybrid cloud position.

“Our research continues to indicate that IBM’s cloud-related revenue lacks enough scale to possess gross and operating margin at corporate average,” wrote Barclays PLC in a pre-earnings brief.

IBM’s traditional businesses continue to get hammered. Systems revenue was down 21 percent and  global financing, sales fell nearly 8 percent. Technology services grew slightly on the back of strong growth in hybrid cloud-related projects. Profit margins on z Systems mainframe grew in line with cyclical trends, but they were offset by declines in margins for the company’s Power and storage systems. Storage value continues to shift to software, IBM said, and flash storage revenues are growing nicely.

Schroeter devoted several minutes of the quarterly earnings call to discussion of IBM’s blockchain activities, which now include blockchain “garages” in New York, London, Tokyo and San Francisco and Singapore. “We are building a complete blockchain platform and are working with more than 100 clients to deliver blockchain as a service,” he said.

IBM is also shifting its intellectual property licensing model away from outright sales and toward licensing deals. “IP income has been flat to down over the next last three to five years, and we have been thinking of new ways to re-invigorate that business,” Schroeter said. “This is a relatively new model for us.”

Adapting to new models is one of IBM’s strengths, Enderle said. “It’s one of the few companies that goes through this kind of rebirth regularly, and these results show the benefits of having that capability,” he said.

Photo by Kansir via Flickr CC

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