IBM earnings show solid growth but stock slides anyway
IBM Corp. beat second-quarter earnings estimates today, but shareholders were unimpressed, sending the computing giant’s shares down more than 4% in early after-hours trading.
Revenue rose 16%, to $15.54 billion in constant currency terms, and rose 9% from the $14.22 billion IBM reported in the same quarter a year ago after adjusting for the spinoff of managed infrastructure-service business Kyndryl Holdings Inc. Net income jumped 45% year-over-year, to $2.5 billion, and diluted earnings per share of $2.31 a share were up 43% from a year ago.
Analysts had expected adjusted earnings of $2.26 a share on revenue of $15.08 billion.
The strong numbers weren’t a surprise given that IBM had guided expectations toward high single-digit growth. The stock decline was attributed to a lower free cash flow forecast of $10 billion for 2022, which was below the $10 billion-to-$10.5 billion range it had initially forecast. However, free cash flow was up significantly for the first six months of the year.
It’s also possible that a report saying Apple was looking at slowing down hiring, which caused the overall market to fall slightly today, might have spilled over to other tech stocks such as IBM in the extended trading session.
Delivered on promises
On the whole, the company delivered what it said it would. Its hybrid platform and solutions category grew 9% on the back of 17% growth in its Red Hat Business. Hybrid cloud revenue rose 19%, to $21.7 billion. Transaction processing sales rose 19% and the software segment of hybrid cloud revenue grew 18%.
“This quarter says that [Chief Executive Arvind Krishna] and his team continue to get the big calls right both from a platform strategy and also from the investments and acquisitions IBM has made over the last 18 months,” said Bola Rotibi, research director for software development at CCS Insight Ltd. Despite broad fears of a downturn in the economy, “the company is bucking the expected trend and more than meeting expectations,” she said.
Software revenue grew 11.6% in constant currency terms, to $6.2 billion, helped by a 7% jump in sales to Kyndryl. Consulting revenue rose almost 18% in constant currency, to $4.8 billion, while infrastructure revenue grew more than 25%, to $4.2 billion, driven largely by the announcement of a new series of IBM z Systems mainframes, which delivered 69% revenue growth.
With investors on edge about the risk of recession and his potential impact on technology spending, Chief Executive Arvind Krishna (pictured) delivered an upbeat message. “There’s every reason to believe technology spending in the [business-to-business] market will continue to surpass GDP growth,” he said. “Demand for solutions remains strong. We continue to have double-digit growth in IBM consulting, broad growth in software and, with the z16 launch, strong growth in infrastructure.”
Krishna called IBM’s current sales pipeline “pretty healthy. The second half at this point looks consistent with the first half by product line and geography,” he said. He suggested that technology spending is benefiting from its leverage in reducing costs, making the sector less vulnerable to recession. ”We see the technology as deflationary,” he said. “It acts as a counterbalance to all of the inflation and labor demographics people are facing all over the globe.”
While IBM has been criticized for spending $34 billion to buy Red Hat Inc. instead of investing in infrastructure, the deal appears to be paying off as expected, Rotibi said. Although second-quarter growth in the Red Hat business was lower than the 21% recorded in the first quarter, “all the indices show that they are getting very good value from the portfolio,” she said. Red Hat has boosted IBM’s consulting business but products like Red Hat Enterprise Linux and OpenShift have also benefited from the Big Blue sales force.
With IBM being the first major information technology provider to report results, Pund-IT Inc. Chief Analyst Charles King said the numbers bode well for reports soon to come from other firms. “The strength of IBM’s quarter could portend good news for other vendors focused on enterprises,” he said. “While those businesses aren’t immune to systemic problems, they have enough heft and buoyancy to ride out storms.”
One area that IBM has talked less and less about over the past few quarters is its public cloud business. The company no longer breaks out cloud revenues and prefers to talk instead about its hybrid business and partnerships with major public cloud providers.
“IBM’s primary focus has long been on developing and enabling hybrid cloud offerings and services; that’s what its enterprise customers want, and that’s what its solutions and consultants aim to deliver,” King said.
IBM’s recently expanded partnership with Amazon Web Services Inc. is an example of how the company has pivoted away from competing with the largest hyperscalers and now sees them as a sales channel, Rotibi said. “It is a pragmatic recognition of the footprint of the hyperscalers but also playing to IBM’s strength in the services it can build on top of the other cloud platforms, its consulting arm and infrastructure,” she said.
Krishna asserted that, now that the Kyndryl spinoff is complete, IBM is in a strong position to continue on its plan to deliver high-single-digit revenue growth percentages for the foreseeable future. Its consulting business is now focused principally on business transformation projects rather than technology implementation and the people-intensive business delivered a pretax profit margin of 9%, up 1% from last year. “Consulting is a critical part of our hybrid platform thesis,” said Chief Financial Officer James Kavanaugh.
Pund-IT’s King said IBM Consulting “is firing on all cylinders. That includes double-digit growth in its three main categories of business transformation, technology consulting and application operations as well as a notable 32% growth in hybrid cloud consulting.”
With the U.S. dollar at a 20-year high against the euro and a 25-year high against the yen, analysts on the company’s earnings call directed several questions to the impact of currency fluctuations on IBM’s results.
Kavanaugh said these are unknown waters but the company is prepared. “The velocity of the [dollar’s] strengthening is the sharpest we’ve seen in over a decade; over half of currencies are down-double digits against the U.S. dollar,” he said. “This is unprecedented in rate, breadth and magnitude.”
Kavanaugh said IBM is more insulated against currency fluctuations than most companies because it has long hedged against volatility. “Hedging mitigates volatility in the near term,” he said. “It does not eliminate currency as a factor but it allows you time to address your business model for price, for source, for labor pools and for cost structures.”
The company’s people-intensive consulting business also has some built-in protections against a downturn, Kavanaugh said. “In a business where you hire tens of thousands of people, you also churn tens of thousands each year,” he said. “It gives you an automatic way to hit a pause in some of the profit controls because if you don’t see demand you can slow down your supply-side. You can get a 10% to 20% impact that you pretty quickly control.”
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