IBM Corp. kicked off the tech sector’s quarterly earnings season with results that indicated that the artificial intelligence dividend has yet to pay off for the big infrastructure players.
Third-quarter earnings of $2.30 per share, excluding nonrecurring items, were eight cents better than consensus estimates. Although revenues rose 2% year-over-year on a constant currency basis, to $14.97 billion, they were slightly below the $15.08 billion consensus.
The revenue miss sent IBM shares down over 3% in extended hours trading. Executives put a positive face on the numbers, saying the software business, which now constitutes 45% of overall revenue, grew 10% from a year earlier, to $6.5 billion, ahead of the $6.4 billion analysts had predicted.
“We’ve been hard at work rebuilding our portfolio to be both sustainable and to have a lot of value for clients,” said Chief Executive Officer Arvind Krishna (pictured). “The fact that 7% of our software growth was organic this year, not acquisitive, gives us confidence about how well that software is being used.”
Krishna said August marked the one-year anniversary of its acquisition of cloud management vendor Apptio Inc., which is achieving “strong synergies with our automation capabilities and broader software portfolio.” He said the pending acquisition of infrastructure management provider HashiCorp Inc. is expected to strengthen IBM’s position in infrastructure automation. Automation revenue rose 13%.
Red Hat payoff
The company’s Red Hat subsidiary, which anchors its hybrid cloud strategy, grew revenue 14%. Krishna noted that the Red Hat business has doubled in size since the acquisition five years ago.
Data and artificial intelligence revenue rose only 5%, but executives said that business is poised to take off. They said IBM’s generative AI business now accounts for about $3 billion in bookings, up from $2 billion last quarter.
“We are very focused on ensuring we get an early lead position and establish IBM consulting as a strategic provider of choice for gen AI,” said Chief Financial Officer James Kavanaugh. “This is a long-term growth factor with a multiplier effect across our software, our platforms and our infrastructure.” About three-quarters of the gen AI business is consulting, and one-quarter is software.
IBM said it sees total revenue growing 1% to 2% in the fourth quarter, to $12 billion, in line with earlier forecasts. It raised its expectation for operating pretax margin extension to one a point a year, “well above our model,” Kavanaugh said. “This is driven by revenue scale, portfolio mix and productivity initiatives, enabling operating leverage and providing investment flexibility,” he said.
Consulting slows
The biggest disappointment in the results was IBM’s massive consulting business, which was flat year-over-year and reflected what Kavanaugh called a “dynamic market environment,” with enterprises spending carefully. Generative AI bookings are expected to restore growth, he said.
The infrastructure business fell 7%, reflecting product cycle forces in IBM’s Z family of mainframes, which declined 19%. The Z family is now in its 10th quarter of availability and due for a refresh. Nevertheless, Kavanaugh said, “the Z 16 program continues to exceed refresh cycles, delivering revenue growth in eight of the last 10 quarters.”
On a segment basis, security revenues were off 1%, transaction processing revenues grew 9%, technology consulting fell 4% and hybrid infrastructure declined 9%.
Free cash flow, a key indicator of dividend growth, rose 23% from a year ago and is expected to grow at least 7% for all of 2024.
Forrester Research Inc. Senior Analyst Dario Maisto said IBM is playing its cards well in AI, noting its decision earlier this week to open-source the latest version of its Granite foundation models. That follows an August announcement in which IBM and the National Aeronautics and Space Administration open-sourced a foundation AI model for analyzing satellite data on Hugging Face Inc.’s distribution platform.
“This move shows IBM’s involvement in the AI market, which is what has been driving the greatest levels of attention in the tech sector still in 2024, along with gen AI,” he said.