International Business Machines (IBM – Free IBM Stock Report), a global supplier of computer hardware, software, and services, and a Dow 30 component, reported September-quarter results that reflect its July 9th acquisition of cloud-computing software provider Red Hat.
Excluding $0.81 a share of mostly non-cash, nonoperating items, largely related to the acquisition, IBM earned $2.68 a share in the September quarter, close to our estimate of $2.70, but short of the $3.42 logged in the year-earlier period.
Revenues declined nearly 4%, but only 0.6% adjusting for currency and divestitures. Red Hat's sales were strong (up 19%), but revenues in IBM's Global Technology Services and Systems businesses also declined. The latter segment was hurt by waning sales of IBM's z14 mainframe computer, which is nearing the end of its product lifecycle.
IBM's gross margin was flattish in the September term, but would have risen 30 basis points adjusting for divestitures. The acquisition and divestiture costs boosted selling expense. Intellectual property income declined. Interest expense more than doubled due to the additional debt to finance the purchase of Red Hat.
By business segment, Cloud and Cognitive Software revenues (which include Red Hat) rose 8%, driven by strength in cloud and data platforms and security software and services. The segment's margin contracted, mainly due to acquisition accounting adjustments.
Global Business Services revenues increased 2%, supported by strength in the consulting business. The gross margin expanded, aided by a shift to higher-value offerings and productivity measures.
These good performances were offset by declines in IBM's other two business segments. Global Technology Services revenues slipped 4%, hurt by declines in the United Kingdom and Germany, and the lower volumes depressed the segment's margin. Meanwhile, Systems revenues fell 14%, reflecting declining sales of z14 mainframes, and segment margins contracted sharply, hurt by unfavorable revenue mix and the costs of bringing a new mainframe to market.
In the year ahead, currency is likely to remain a headwind. But we look for IBM to make more progress integrating Red Hat's Linux operating system, RHEL, and hybrid cloud platform, OpenShift, into its Cloud & Cognitive Software and Business Services offerings. Red Hat is expected to drive faster growth in IBM's business of helping companies shift their workloads to a hybrid cloud environment.
The Technology Services business will face tough comparisons in the December period. With revenues likely to remain weak, management is deemphasizing low-margin offerings, accelerating its use of automation, and aims to rein in variable spending.
Systems revenues ought to improve as sales of its new z15 mainframe, which it recently rolled out, gain traction. In all, IBM looks for operating earnings of $12.80 a share in 2019, excluding $2.22 of acquisition, retirement, and other so-called nonoperating costs. For 2020, we are maintaining our share-net estimate of $13.40 for now.
Note that IBM is making progress reducing its debt. To this end, the company suspended its share repurchase program in July and plans to wind down its OEM commercial financing operations by the end of 2019, which ought to help reduce borrowings. At the end of June, it had $73 billion in debt, including the additional borrowings needed to fund the Red Hat transaction, but had $66 billion at the end of September.
Apparently frustrated by IBM's inability to reinvigorate revenue growth, investors bid the stock down following the September-period earnings announcement. The dividend yield is very attractive, but unless IBM makes faster bottom-line progress, the stock doesn't stand out for total return potential over the pull to 2022-2024.
About The Company: International Business Machines Corporation is a worldwide supplier of technology and business services, software, and systems hardware. Revenues in 2018 can be broken down as follows: Technology Services & Cloud Platforms, 43%; Cognitive Solutions, 23%; Global Business Services, 21%; Systems, 10%; Financing & Other, 3%.
– Theresa Brophy
