IBM's focus on cloud and software isn't novel – it's survival

Hardware division is dying, 18 quarters of shrinking revenue, the writing is stained on the wall

IBM believes it is closer than ever to returning to overall revenue growth for the first time in more than four years.

That's looking at the whole picture, though: while cloud and software are pulling in the right direction, the corporate goliath's remaining hardware operations are still looking pretty grim.

Big Blue said that with revenues only falling by one per cent on the year-ago quarter, it may soon be able to return to overall growth around a new business model focusing on cloud and analytics services such as Watson. The IT titan has suffered 18 quarters now of revenue decline.

For the Q3 2016 period [PDF], ended September 31:

  • Revenues of $19.2bn were down one per cent year over year when adjusting for currency or zero per cent if not. $8bn of that came from "strategic imperatives," up 16 per cent year-on-year, which includes $3.4bn of cloud sales, up 44 per cent from a year ago.
  • That "strategic imperative" core of the security, cloud, analytics, mobile and social businesses now makes up about 40 per cent of IBM's total sales.
  • Net income of $2.9bn was down four per cent from $2.95bn last year with a 2.1 point drop in gross margin to 46.9 per cent.
  • Earnings per share (non-GAAP) of $3.29 topped analyst estimates of $3.24.
  • Here's the revenue breakdown of the main divisions compared to Q3 2015:
    • Cognitive Solutions: $4.24bn up 4.5 per cent from $4.05bn. Cloud revenues within this wing grew 74 per cent and solutions software grew eight percent.
    • Global Business Services: $4.19bn pretty much flat on $4.2bn. This includes consultancy work, global process services, and application management.
    • Technology Services & Cloud Platforms: $8.75bn up two per cent from $8.54bn. This includes infrastructure services, technical support services, integration software. Growth of 45 per cent in "strategic imperatives" sales within this segment was "driven by strong hybrid cloud services performance," we're told.
    • Systems: $1.56bn down 21 per cent from $1.97bn. This includes systems hardware and operating systems software; the fall is due to "z Systems product cycle dynamics," we're told.

Not surprisingly, IBM says that it wants to increase the focus on those core operations going forward, as well as growing its intellectual property operation back to the levels of previous years. Big Blue says that cloud (revenues up 42 per cent) and analytics (revenues up 14 per cent) will be key areas of focus.

"There's a tremendous amount of change in our industry, and we're continuing to invest where we see the best opportunities," IBM CFO Martin Schroeter said.

"With this, we're addressing new opportunity areas and building new markets, as well as delivering innovation in our existing businesses."

Investors, meanwhile, aren't so sure. IBM stock is down 2.9 per cent in after-hours trading at $150.24.

"Given its very high marginal contribution, we believe that it will be difficult for IBM to grow earnings going forward if software revenues continue to decline, and encourage investors to monitor this metric closely," Toni Sacconaghi, a Bernstein senior research analyst, told investors in a note ahead of today's IBM earnings release.

"IBM's reported revenue growth is optically starting to improve – YoY compares are easier in FY16, currency is now providing a positive top line boost, and acquisitions are bolstering revenue. However, it is important to filter out these effects to get a sense of how the "core" business is doing.

"For us, the key metric for investors to watch is whether IBM's revenue growth – adjusting for currency, acquisitions and divestitures – is beginning to improve. Over the last couple of years, total company revenues on this basis declined by one to two per cent, and they declined four per cent last quarter." ®

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