IBM Sales Drop and Executives Aren't Ready to Discuss Red Hat

(Bloomberg) -- International Business Machines Corp. shares slipped after executives were tight-lipped about the company’s $34 billion Red Hat acquisition and how it will help growth in cloud computing.

The deal closed last week and IBM reported quarterly results on Wednesday. Analysts tuned into a conference call to glean fresh details on the impact of adding Red Hat’s open-source software to IBM’s current offerings. But Chief Financial Officer Jim Kavanaugh declined to answer any questions on Red Hat, saying the company will share an updated financial forecast at its annual investor briefing on Aug. 2.

“Everyone is looking forward to this investor update," Edward Jones analyst Logan Purk said. “It’s paramount that IBM really nails that."

Second-quarter revenue fell 4.2 percent to $19.2 billion, slightly beating the average analyst estimate. It was the fourth consecutive quarter of revenue declines for the Armonk, New York-based company. The shares declined 1.5% in extended trading.

After lagging in the cloud market for more than a decade, IBM is pegging its future to a hybrid cloud strategy that will allow it to offer services on both private and rival public clouds. Chief Executive Officer Ginni Rometty paid a rich premium for Red Hat in order to help the 108-year-old company catch up with cloud market leaders Amazon.com Inc. and Microsoft Corp. The deal officially closed last week, so Red Hat’s contribution hasn’t shown up in IBM’s quarterly financial reports yet.

Rometty has touted the Red Hat deal, which was announced in October, as a “game changer” for IBM, claiming it will reset the entire cloud landscape. IBM has estimated only 20% of enterprise applications have made the shift to cloud so far and Rometty believes the company is in prime position to conquer the remaining market.

This quarter’s results are significant because they represent the last clean read of IBM’s trajectory before the integration of Red Hat, Sanford C. Bernstein analysts Toni Sacconaghi and Corry Wang wrote in a note before the results were released.

Revenue in the global technology services unit, which includes cloud infrastructure and technology support, was $6.8 billion, down 6.7%, from a year earlier. The division shrank by the same amount in the previous quarter.

The drop was the result of IBM ending some unprofitable businesses, Kavanaugh said. "We will see improvements of those numbers as we get into the second half," he added. Technology services is IBM’s biggest business unit, pulling in almost 40% of total sales.

Earnings excluding some costs were $3.17 a share in the three months ending June 30, higher than the $3.08 average Wall Street estimate. For the full fiscal year, IBM stuck to a forecast of at least $13.90 a share.

Big Blue has reported shrinking revenue growth since 2012. There was a modest and temporary reprieve in early 2018, but the slight uptick in sales stemmed from its legacy mainframe computers, rather than newer technologies like artificial intelligence, and cloud computing. In the second quarter, IBM reported revenue growth of 3.2% in cloud and cognitive solutions, stronger than in the previous quarter.

IBM’s lackluster sales are due to a cannibalization of its legacy technology and data centers, Wedbush Securities Inc. analyst Moshe Katri said in an interview before the results were released. While the company has made significant strides toward new technologies like cloud computing, these services are capital and labor light, Katri said. “It’s time to grow that business and make it really count for overall top-line growth,” he said.

The future of IBM is hybrid cloud, said Ian Campbell, chief executive officer of Nucleus Research. “But the biggest challenge is they are very late to the cloud party,” he said. Amazon Web Services and Microsoft Azure have dominated the public cloud space for years and IBM, once a tech titan, is considered small-fry in comparison. “Cloud is the make or break for IBM, but nobody even knows they’re there," Campbell said.

On Tuesday, IBM announced that AT&T Inc. would be shifting its internal software applications to the IBM cloud in a multi-year agreement. This is mutually beneficial for both companies, Campbell said. “But it feels like two B-list celebrities announcing an engagement in the hopes of becoming an A-lister,” he added. “This is not going to move the needle."

To contact the reporter on this story: Olivia Carville in New York at ocarville1@bloomberg.net

To contact the editors responsible for this story: Jillian Ward at jward56@bloomberg.net, Molly Schuetz, Alistair Barr

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