IBM Earnings Preview: Weak Demand Could Weigh On Results

by Trefis Team
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Quick Take

  • IBM posted disappointing Q1 numbers and reported a 5% y-o-y decline in revenues to $23 billion. The primary reason for the decline was the failure to close deals for its Middleware and Server division in Q1. IBM expects to close many of these deals in Q2 so we are looking for updates, which should help stabilize revenue.
  • IBM embarked on a “workforce rebalancing” or job cuts during Q2, and we expect updates on these cost savings and progress.
  • We expect revenues from the GTS and GBS divisions to suffer in Q2 due to soft demand for IT services around the world.
  • According to IDC, the global server market saw a 7.7% decline in revenue in Q1. We expect this trend to continue and expect IBM to report lower revenues for server division. However, strong sale of System-Z server will boost its server division revenue.

International Business Machines (NYSE:IBM) is set to announce its Q2 earnings on July 17. In Q1, IBM reported division wide decline in revenue. Revenue declined by 5% to $23.40 billion, negatively impacted by cross currency headwinds, and the company’s failure to close deals for its software and server divisions.

In its Q1 earnings announcement, IBM stated that it expects to close most of these rollover deals for software and mainframe in Q2, and therefore, report stronger revenue figures. We are closely following IBM’s earning announcement for any updates on this. However, we expect that weakness in IT spending will negatively affect IBM’s revenues. Additionally, we expect revenue growth at Global Technology Services (GTS) and GBS divisions will suffer the most as demand for IT services has been soft during the quarter.

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 in Q1. We expect IBM will continue to report revenue growth in these new business initiatives. Additionally, we are carefully monitoring revenues from growth markets as these can offset the declines in the GTS and GBS divisions.

See our full analysis on IBM

Cost Savings Due To Layoffs

IBM posted disappointing Q1 numbers and reported a 5% y-o-y decline in revenues to $23 billion. Additionally, IBM also posted a 1% y-o-y decline in net income to $3 billion in Q1. IBM embarked on a “workforce rebalancing” or job cuts during Q2. Most of the job cuts were in the ailing system and technology group. [1] In this earnings announcement, we want to know the expected cost savings that IBM can generate from these job cuts going forward.

Middleware To Report Growth

The Middleware division, together with Operating Systems division, is the biggest contributors to IBM stock value and makes up nearly 60% of our estimate. During Q1, the software division (middleware and operating systems combined) reported revenues of $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. In this earnings announcement, we are closely monitoring the new orders bagged by IBM and want to know whether IBM was able to close pending deals or not.

Additionally, we want to know more about demand for its Rational suite of software that saw a 2% y-o-y decline in revenues. The Middleware and Operating System divisions are important for our valuation of IBM as these have the highest EBITDA margins of almost 50%. We expect IBM will continue to report high margins for this division. Moreover, we expect revenue growth to recover in mid-single digits in Q2.

Business Environment To Weigh Down GTS and GBS revenues

The Technology Services division (GTS) and Business Services (GBS) division contribute over 35% to IBM’s stock value according to our estimates. In Q1, GTS reported a 4% decline and GBS reported a 3% decline in revenues. Accenture (NYSE:ACN), in its results declared last month, reported that soft demand for IT services hampered its business. [2] We believe that IBM’s business will also suffer due to a slowdown in demand for IT services. We therefore expect IBM to report lower revenues from GTS and GBS in Q2. However, IBM’s foray in high growth and high value business such as business analytics, Smarter Planet and cloud computing will help in offsetting the decline in GBS revenue.

In Q1, IBM reported that it has signed more long-term contracts, and we believe that these contracts will help in stabilizing GTS revenues in Q2. [3] We will be closely following new developments in these divisions during this earnings announcement. Additionally, backlog contributes 70% to services revenue, and we expect this mix to improve in Q2. We expect the company to report this change in revenue mix in the upcoming earnings announcement.

Server Division To Report Lower Revenues

According to IDC, the worldwide server market revenues declined by 7.7% in Q1 2013 due to lower demand in the market. [4] Additionally, IBM’s market share in servers declined from 27.2% in Q1CY12 to 25.5% in Q1CY13. We expect the decline in demand for servers to continue in Q2 as well, and we expect IBM to report lower revenues for the server division.

However, its high end System-Z server saw 7% revenue growth in Q1, which shows future promise. IBM has stated that it will deliver double-digit revenue growth in System-Z vertical in second quarter. We expect that adoption of System-Z will continue globally. We, therefore, expect that high demand of System-Z will offset soft demand for its System-x and Power system servers. We are closely watching IBM’s revenue from System-Z servers as it is an important driver for our revenue forecast of server division. Currently we project System-Z units shipped grow from around 21,000 in 2012 to 34,000 by the end of our forecast period.

We currently have a $210 Trefis price estimate for IBM, which is about 10% higher than the current market price.

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Notes:
  1. See Job Cuts Take Hold At IBM As It Looks To Rein In Costs []
  2. See Accenture Lowers Its Guidance As Consulting Revenues Decline []
  3. See IBM Lays An Egg On Failure To Convert Deals And Growth Market Weakness []
  4. Worldwide Server Market Revenues Decrease 7.7% in First Quarter as Market Demand Slows, May 29 2013, www.idc.com []
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