A Market Referendum on the Evolution of IBM Common Stock (NYSE:IBM)

IBM Common Stock (NYSE:IBM) is getting smacked today after hitting the wires yesterday afternoon with a bit of a rotten egg. You probably know the big headlines: back to contracting revenues, a miss on gross margins, and lackluster guidance was maintained.

That was enough to sink the stock down to new multi-year lows.

IBM Common Stock (NYSE:IBM) did “beat the number” in terms of EPS, with a $3.42 print. But the top line came in below market expectations, down 2.1% from last year, to $18.76 bln. The culprit behind this contraction was attributed to a miss in expectations as far as AI and Cloud growth trends.

Margins on a pre-tax basis were up 50 basis points to 19.2%, from 18.7% a year ago benefiting somewhat from lower SG&A and improved margin stabilization.

Also, IBM backed its previous FY18 EPS outlook; the company continues to expect non-GAAP EPS of at least $13.80. Further, IBM left FCF guidance unchanged at approximately $12 bln, with a realization rate greater than 100%, as management highlighted expected cash taxes and CapEx are largely behind IBM.


Piece By Piece

Global Business Services, which includes consulting, application management and global process services, reported Q3 revenue growth of 1% to $4.1 bln (or up 3% on a constant currency basis).

Systems, which includes systems hardware and operating systems software, reported Q3 revenues of $1.7 bln, up 1% (and up 2% in constant currency), driven by growth in Power and IBM Z.

Technology Services & Cloud Platforms, which includes infrastructure services, technical support services and integration software, reported revenue declines of 2% (flat in constant currency) to $8.3 bln.

Cognitive Solutions, which includes solutions software and transaction processing software, saw revenue declines of 6% (down 5% in constant currency) to $4.1 bln.

Global Financing, which includes financing and used equipment sales, saw revenues of $388 mln, down 9% (or down 7% in constant currency).


So, Why is the Stock Getting Hit?

The stock is getting hit mostly because it was being treated as if it was something it really isn’t: an AI and Cloud play.

Okay, it is an AI and Cloud play. But not in the same way that ADBE, TTD, or NUAN is. The growth inherent in those themes isn’t enough to move the needle as much as investors were hoping, especially if the company isn’t executing on those themes in a truly market-leading sense.

John Chambers (former Cisco CEO) used to talk about this all the time: Only do what you can be number 1 or 2 at doing. Right now, IBM is doing lots of things where it ranks number 3 or worse.

The team is actually doing a good job at managing that strategic reality. But the vision for the whole machine is not coherent at this point because they aren’t leading at anything that is truly a high-growth theme.

Generally speaking, management is attempting to turn the business into a higher-margin, lower-cost cloud operation, but the traction seems to have slowed in Q3 — in fact, it would appear IBM failed to sign any new cloud business in the quarter.

Shares were priced as if this was something it simply isn’t. That pricing error is being rectified today by the market.

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