It has been about a month since the last earnings report for IBM (IBM). Shares have added about 0.3% in that time frame, underperforming the S&P 500.
Will the recent positive trend continue leading up to its next earnings release, or is IBM due for a pullback? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important catalysts.
IBM’s Q3 Earnings Beat, Revenues Lag Estimates
International Business Machines Corporation reported third-quarter 2020 non-GAAP earnings of $2.58 per share, which surpassed the Zacks Consensus Estimate by 1.2%. However, the bottom line fell 4% on a year-over-year basis.
Revenues of $17.56 billion lagged the Zacks Consensus Estimate by 0.3% and declined 2.6% (as reported) on a year-over-year basis. At constant currency (cc), the top line fell 3.5%. Meanwhile, adjusting for currency and divested businesses, revenues were down 3.1%.
Revenues from signings improved 5% (at cc) in the third quarter to $9.5 billion. Backlog amounted to $108 billion, down 1% at cc (remained flat at actual) on a year-over-year basis.
Nevertheless, total Cloud revenues were $6 billion during the quarter, up 19.2% year over year. Adjusting for currency and divested businesses, total cloud revenues increased 18.9%. The company witnessed solid uptake of cloud-based solutions and digital transformation offerings, driven by synergies from Red Hat acquisition.
Spin-Off to Boost Prospects in Hybrid Cloud
IBM had recently announced the spin-off of its legacy Managed Infrastructure Services business in a bid to accelerate its hybrid cloud growth strategy. The company aims to focus better on enabling clients with accelerated digital transformation and capitalize on “the $1 trillion hybrid cloud opportunity.”
The company’s Managed Infrastructure Services, a unit of its Global Technology Services division, will be spun off into a new public company or NewCo (set to be named later).
The spin-off is anticipated to fortify its presence in two different territories by creating two entities to realize business goals and best outcomes. IBM’s open hybrid cloud platform and AI expertise are poised to get a boost with the new deal. Meanwhile, NewCo is set to gain new capabilities and greater agility to modernize the architecture of the enterprises.
Synergies from Red Hat Acquisition
Revenues from Red Hat in the third quarter increased 17% (up 16% at cc) on a normalized basis. The buyout has helped IBM to enhance containerized software capabilities and accelerate service engagement. Moreover, OpenShift and Ansible have supported advancements in application and technology developments. Currently, more than 2,600 clients are using Red Hat and IBM’s hybrid cloud platform.
Furthermore, in the third quarter, the company added 125 IBM Services clients that are leveraging Red Hat technology.
Management is optimistic about enhancing utility of hybrid cloud services based on architecture built by IBM and Red Hat. In fact, IBM is leveraging OpenShift container platform, to enable clients to upscale business operations, in a secure manner, via AI-powered Cloud Paks.
Additionally, digital transformation wave has bolstered adoption of cloud-based QRadar, and Identity and Trust services, and CloudPak for Security offerings.
Geographic Revenue Details
Revenues from Americas declined 3% year over year at cc (excluding divestiture impacts) and were $8.1 billion. Revenues from Europe, Middle-East and Africa were $5.6 billion, down 3% year over year. Meanwhile, revenues from Asia-Pacific totaled $3.9 billion, declining 5% on a year-over-year basis.
Cloud & Cognitive Software Segment
Cloud & Cognitive Software segment’s revenues-external rose 6.8% year over year (up 5.8% on cc basis) to $5.55 billion. The upside can be attributed to synergies from Red Hat acquisition and growth in cloud, Data & AI, security and IoT solutions. Markedly, cloud revenues surged 63% to $1.8 billion.
Revenues in the Cloud and Data platforms increased 20% year over year (up 19% on cc basis) to $2.8 billion. The platform is gaining from Red Hat’s acquisition synergies and traction in Cloud Paks suite.
Revenues from the Cognitive Applications inched up 1% year over year (remained flat at cc) to $1.3 billion on strength in Security and Supply Chain offerings. Revenues from the Transaction Processing Software, which includes software that runs mission-critical workloads, declined 9% on a year-over-year basis to $1.5 billion.
Global Business Services Segment
Revenues in the Global Business Services (GBS) -external segment totaled $3.97 billion, which declined 4.7% (down 5.8% at cc) from the year-ago quarter.
Consulting revenues fell 4% year over year at cc to $2 billion. Application Management and Global Process Services revenues declined 8% and 3% (at cc) year over year to $1.8 billion and $0.2 billion, respectively.
Segmental revenues pertaining to cloud advanced 9% at cc from the prior-year quarter’s reported figure to $1.4 billion.
Global Technology Services Segment
Revenues from Technology Services-external fell 3.6% (down 4.3% at cc) from the year-ago quarter to $6.46 billion.
Segmental revenues pertaining to cloud advanced 8% at cc from the prior-year quarter’s reported figure to $2.3 billion.
Infrastructure & Cloud Services and Technical Support Services revenues declined 4% and 6% (at cc) year over year to $4.9 billion and $1.5 billion, respectively.
Systems revenues-external fell 15.1% (down 16% at cc) on a year-over-year basis to $1.26 billion.
Systems Hardware revenues fell 19% (at cc) year over year to $0.9 billion. Operating Systems Software declined 8% (at cc) year over year to $0.3 billion.
IBM Z revenues fell 20% year over year. Power revenues slumped 16% from the year-ago quarter. Storage revenues declined 20% year over year.
Segmental revenues pertaining to cloud dropped 4% at cc from the prior-year quarter’s reported figure to $0.5 billion.
Finally, Global Financing (includes financing and used equipment sales) revenues-external fell 20.5% year over year (down 20.3% at cc) to $273 million.
Non-GAAP gross margin expanded 160 basis points (bps) year over year and came in at 49%. The gross margin benefited from robust mix and high-value software contribution.
Non-GAAP Research, Development & Engineering (R, D&E) expenses increased 1% year over year to $1.52 billion.
Non-GAAP Selling, General And Administration (S,G&A) expenses declined 4.5% year over year to $4.37 billion.
Non-GAAP pre-tax income margin from continuing operations was 14.7% compared with year-ago period’s 13.3%.
Balance Sheet & Cash Flow Details
As of Sep 30, 2020, IBM had $15.8 billion in total cash and marketable securities compared with $14.3 billion as of Jun 30, 2020.
As of Sep 30, 2020, total debt (which includes $20.9 billion from Global Financing debt) was $65.4 billion, compared with $64.7 billion as of Jun 30, 2020.
The company reported cash flow from operations of $4.3 billion ($1.9 billion when excluding Global Financing receivables) during the third quarter, compared with $3.6 billion in the second quarter.
IBM generated free cash flow of $1.1 billion in the third quarter, compared with $2.3 billion in the second quarter.
Moreover, the company returned $1.5 billion to shareholders through dividends.
For 2020, IBM refrained from providing any guidance, citing business uncertainty.
Nevertheless, management stated that fourth quarter is a seasonally strong quarter. The company is witnessing robust pipelines across hybrid cloud and data platform, AI solutions, in Cognitive Apps business driven by strength in Cloud Paks and Security, cloud-based transformation services in GBS segment, and App modernization offerings. Also, management is banking on advancement in Red Hat “actual backlog growth.”
Moreover, gains from rapid uptake of IBM z15 is anticipated to be a tailwind. The company also anticipates to end 2020 with reduced debt levels.
How Have Estimates Been Moving Since Then?
It turns out, estimates review have trended downward during the past month. The consensus estimate has shifted -51.2% due to these changes.
Currently, IBM has a nice Growth Score of B, though it is lagging a bit on the Momentum Score front with a C. However, the stock was allocated a grade of A on the value side, putting it in the top quintile 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. It's no surprise IBM has a Zacks Rank #4 (Sell). We expect a below average return from the stock in the next few months.
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