Analytics, Smarter Planet, IBM cloud and other new initiatives have carried International Business Machines, (NYSE:IBM) for the past few quarters and this continued in Q1 2013 as well. The company reported GAAP EPS of $2.70 for Q1CY13, which is up for the 11th consecutive year mainly due to a stock buyback. Revenue declined by 5% at $23.40 billion, negatively impacted by cross currency headwinds and the company’s failure to close deals for its software and server divisions.  However, IBM expects to close most of these rollover deals for software and mainframe in Q2, and therefore, report stronger revenue figures next quarter. Net income was $3 billion for the quarter, down 1% y-o-y.
Revenues from cloud computing and analytics initiative continued to see growth in Q1. However, its core software business had a lackluster performance in the quarter and revenues were $5.6 billion, flat year-over-year (y-o-y) and up 1% in constant currency. Its Global Technology Services (GTS) revenues were $9.6 billion, down 4% y-o-y and down 2% in constant currency. Global Business Services (GBS) revenues were $4.5 billion (ex-Retail Store Solutions), down 3%y-o-y and flat in constant currency. The server and storage division continued to disappoint and reported revenues of $3.1 billion, down 17% year-to-year or 13% in constant currency.
IBM in its 2015 roadmap stressed that it was focused on emerging growth economies, big data analytics and cloud computing services. While IBM reported a lackluster performance from growth economies at 1%, its new initiatives in Business Analytics, Smarter Planet and cloud delivered stronger growth. IBM has maintained its EPS guidance for 2013 at least $15.53 and operating (non-GAAP) EPS of at least $16.70.
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Middleware Suffers As Company Fails to Close Deals In Q1
The Middleware division together with Operating Systems division are the biggest contributors to IBM stock value and makes up nearly 55% of our estimate. During the quarter, the software division (Middleware and operating systems combined) reported revenues at $5.6 billion, flat y-o-y and up 1% in constant currency. The software division revenue growth was negatively impacted as IBM failed to close a number of deals in Q1.
The Middleware division still managed to report 1% increase in revenue, and we expect this trend to continue. IBM’s flagship WebSphere software reported 6% revenue growth and its Tivoli suite grew 1%. Its Rational Suite of software and information management software continued to suffer due to low demand and transactional rollover into the next quarter.
Middleware and operating system divisions are important for our valuation of IBM as these have the highest EBITDA margins at 48%. We expect IBM will continue to report high margins for this division. Moreover, we expect revenue growth to recover in mid-single digits for the rest of the year as IBM looks to close pending Q1 deals in Q2.
Restructuring Contract Costs GTS Revenue Growth
The Technology Services division (GTS) contribute over 24% to IBM’s stock value according to our estimates. In Q1, GTS reported a 4% decline in revenues at $9.6 billion as IBM is restructuring low margin outsourcing contracts to improve profitability. However, the Integrated Technology Services division reported 2% increase in revenue as demand in growth markets increased. Currently we estimate the EBITDA margin at 22.2% for this division through our forecast period; however, if IBM is able to deliver growth in margins, our stock price estimate will increase.
GBS Revenue Stabilize As IBM Focuses On High Growth Business
The Business Services division (GBS) contributes over 10% to IBM’s stock value according to our estimates. In Q1, GBS revenues were $4.5 billion, down 3% and flat in constant currency. GBS revenues were stable as its new initiatives in Business Analytics (7% growth), Smarter Planet (25% growth) and Cloud (70% growth) reported good growth. As these verticals become a larger part of GBS, they’ll contribute more to the top line performance.
As per our pre-earnings article (see: IBM Earnings preview), the segment reported growth in its backlog, which grew by 1% (5% in constant currency) to $141 billion in Q1. The company also reported that it has signed more long-term contracts that will bring stability and growth to its services revenues in coming quarter. We expect revenue from backlog to increase from $9.3 billion to $13.4 billion at the end of our forecast.
Server Division Suffers As Deals Fall Through
While its System-Z reported 7% growth in revenues, Power Systems and System-x revenues continued to decline by 32% and 9% respectively. The drop in revenue was accentuated by deals that did not go through in Q1. IBM has stated that it will deliver double-digit revenue growth in System-Z vertical in second quarter. System-Z is an important driver for our revenue forecast of server division. We expect that adoption of System-Z will continue globally. Currently we project System-Z units shipped grow from around 21,000 in 2012 to 34,000 by the end of our forecast period.
Growth Economies Disappoint
The Americas’ revenues were $10 billion, a decrease of 4% y-o-y while revenues from the EMEA region (Europe/Middle East/Africa) were $7.3 billion, a decrease of 4% y-o-y. Asia-Pacific revenues declined by 7% y-o-y to $5.7 billion. Revenues in the BRIC countries — Brazil, Russia, India and China — contracted 1%. While the economic slowdown in America and Europe continued to drag revenues lower, revenues from growth economies declined because IBM witnessed saw in large deals and a slowdown in low-end and mid-range products. However, IBM expects that revenues from growth economies will grow in coming quarter.
We are currently in the process of updating the IBM model. At present we have a $225 Trefis price estimate for IBM which is about 10% higher than the current market price.Notes: