International Business Machines Earnings: What to look for from IBM

International Business Machines Corp. (IBM) just finished its first quarter under the leadership of recently appointed CEO Arvind Krishna. It wasn’t an easy quarter to navigate, as the global economy reeled from the coronavirus pandemic. Krishna, principal architect of IBM’s $34 billion acquisition of open source and cloud software company Red Hat in 2019, wants to transform IBM into a major player in the field of cloud computing.  But one of his main focuses over the past few months has been trying to weather the economic fallout of the pandemic. IBM’s Q2 2020 earnings report, which will be released on July 20, 2020, will show how well he’s been doing.

One key metric to keep an eye on is the revenue from IBM’s largest segment, Global Technology Services (GTS). Analysts are expecting IBM’s adjusted earnings per share (EPS) to fall sharply in Q2 2020, while total revenue and GTS revenue are expect to decline less sharply.

Over the past 12 months, IBM has underperformed the broader market. The S&P 500 has recovered better than IBM following the pandemic-induced market crash that began in mid-February and bottomed around mid-March. The company’s shares have posted a total return of -9.6% compared to the S&P 500’s 6.8%. All figures are as of July 16, 2020.

IBM’s shares initially fell after reporting earnings that met analysts’ expectations for Q1 2020, but then continued to trend higher over the next several days. IBM posted an 18.0% fall in adjusted EPS for the quarter, marking the third consecutive quarter of earnings declines. Earnings took a hit from approximately $0.9 billion in restructuring charges related to the GTS segment. Revenue declined by a more modest 3.4%, but it was the sixth year-over-year (YOY) decline in seven quarters. IBM also withdrew full-year guidance due to the COVID-19 crisis.

But even before the pandemic, IBM had been struggling to perform across both the top and bottom lines. Adjusted EPS fell 3.4% in Q4 2019, the second consecutive quarter of declines and the fourth decline in five quarters. Revenue grew at a meager 0.1% during Q4, marking the first quarter of YOY revenue growth since Q2 2018. Nevertheless, the company’s shares got a boost, and by early February looked ready to start outperforming the broader market. Then markets crashed due to the pandemic.

While the market has recovered and is close to hitting previous highs, IBM’s shares have mostly moved sideways over the past several months. Analysts are expecting declines in both adjusted EPS and revenue the size of which the company has not seen in at least 14 quarters. Adjusted EPS is expected to fall 34.0% while revenue is expected to fall 7.9%.

Source: Visible Alpha

As mentioned, a key metric to focus on is revenue growth in IBM’s Global Technology Services (GTS) unit. GTS is IBM’s information technology (IT) infrastructure and platform services business, and is its largest single segment, accounting for about 35% of the company’s total revenue in 2019. The business has been a major drag on the company, posting revenue declines in 13 of the last 17 quarters.

However, that revenue share has been falling. GTS comprised nearly 37% of IBM’s total consolidated revenue in 2018. The segment posted YOY revenue declines of 5.9% and 4.8% in Q1 2020 and Q4 2019, respectively. Analysts are expecting another decline of 7.8% for Q2 2020.

One of the main reasons IBM’s overall revenue numbers haven’t fallen as sharply is due to the strong growth in the company’s Cloud & Cognitive Software segment, which grew 5.5% in Q1 2020. That segment contains Red Hat, a company specializing in open-source software and cloud computing. While revenue attributable to Red Hat was up 18% for Q1 2020, its relative size means that growth doesn’t make up for the declines in IBM’s GTS segment. Therefore the acquisition of Red Hat won’t be enough to stop overall sales declines unless IBM manages to halt the continued decline of GTS revenue or cloud revenue grows far faster than expected.