IBM Misses Revenue Estimates on Drag From Legacy IT Unit

(Bloomberg) -- International Business Machines Corp. reported revenue that missed analysts’ estimates, highlighting the challenge of fulfilling its pledge to return to growth this year as it prepares to spin off its low-growth legacy computer services unit. The shares dropped in extended trading.

Sales rose 0.3% to $17.6 billion in the three months ending Sept. 30, the Armonk, New York-based technology company said Wednesday in a statement. Analysts were expecting $17.8 billion, on average, according to data compiled by Bloomberg. 

The underwhelming performance also comes after a more optimistic second quarter, when the company reported its biggest increase in revenue in three years. This time, weak sales in IBM’s legacy IT management and systems units outweighed robust demand for cloud computing, where the company is pinning its hopes for a turnaround.

“We continue to make progress but we have more work to do,” Chief Financial Officer Jim Kavanaugh said in an interview. “The fourth quarter is going to be a major transition to the new IBM.”  

The Global Technology Services segment posted a 4.8% decline in sales from a year earlier. The division, which includes infrastructure service operations like managing client data centers and traditional information-technology support, comprises about a third of IBM’s total revenue. A large portion of the unit will be spun out Nov. 3 into a new company called Kyndryl. IBM said that excluding Kyndryl, revenue would have been up 2.5% in the third quarter.

Kavanaugh said that the weakness in GTS was “not unexpected,” with clients “pausing to re-evaluate” amid the impending spinoff.

The separation will cap IBM’s fourth major transformation and cement its pivot away from slower-growth mainframe computing and IT services. Even before taking over from Ginni Rometty in April 2020, Chief Executive Officer Arvind Krishna was a key architect of IBM’s hybrid-cloud strategy, which lets clients store data in private servers and public clouds, and oversaw the $33 billion acquisition of Red Hat. Since then, Krishna has worked to modernize Big Blue and revive growth by shifting into the faster-growing and higher-margin cloud services dominated by Microsoft Corp. and Amazon.com Inc., and artificial intelligence.

“Post-separation, the company should be leaner as it sheds troubled areas,” CFRA Research analyst David Holt wrote in a note to clients. Investors should “monitor any future developments around incremental revenue contribution linked to Kyndryl beyond 2022 given IBM retained products that have overlap with the spun-out business.”

IBM reported revenue rose 2.5% in its Cloud and Cognitive Software division and 12% in Global Business Services, which includes consulting. The company’s systems segment, which houses hardware and operating systems software, fell 12% to $1.1 billion, a function of nearing the end of the mainframe product cycle which is in its ninth quarter, Kavanaugh said.

Total cloud revenue over the last 12 months grew 14% to $27.8 billion with Red Hat sales increasing 17% during the quarter. 

Earnings excluding some costs were $2.52 a share, falling short of the average analyst estimate of $2.53. Gross margin was 48%, down 1% from a year ago and less than the 49.6% analysts expected.

IBM shares have gained 13% this year through the close of trading Wednesday, lagging the 21% gain in the S&P 500 Index. The stock fell 4.6% in extended trading after the results were released.

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