International Business Machines (NYSE:IBM) posted its Q4 results on January 21. The company reported a decline in revenues due to cross currency headwinds and low demand for its servers. While the revenues declined by 5% year on year to $27.7 billion, the company reported 6% growth in net income to $6.2 billion. Diluted GAAP EPS also rose by 12% to $5.73 during the quarter, lifted by share repurchases.
Its core software business posted mid-single digit gains, primarily due to 5% year-on-year growth in branded middleware revenues. Furthermore, Global Business Services (GBS) revenues grew by 4% year over year in constant currency to $4.7 billion, buoyed by growth in its cloud computing and analytics initiatives. However, its Global Technology Services (GTS) revenues declined by 1% to $9.9 billion. IBM’s system and technology division continued to disappoint and reported 25% year-over-year decline in revenues to $4.3 billion, due to product transitions and market disruptions.
For the full year 2013, the company reported 5% year-over-year decline in revenues to $100 billion, and 8% year-over-year decline in pre-tax income to $21.4 billion, due to losses at its hardware (server and storage) division. While software and GBS revenues grew by 3% in constant currency, GTS and hardware divisions continued to underperform their respective industries and declined by 1% and 18% year on year, respectively.
Server And Storage Division Drags Revenues And Profitability
Server and storage division, which was once the cash cow of the company, is witnessing a continuing decline in revenues. During the quarter, revenues for this division declined by 25% to $4.3 billion. Furthermore, the full year revenues declined by 19%, and the division also reported a pre-tax loss of $500 million, which negatively impacted IBM’s overall revenues and profitability.
While revenues for System-Z, Power Systems and System-X declined by 37%, 31% and 15% respectively, Storage revenues declined by 12%. The decline in server revenues continue to reflect the expected weak demand in global server shipments in Q4. However, we expect that the demand for System-Z will rise as IBM’s clients continue to demand mainframes with high processing power and big data analytics capability. It is in the back end of a product cycle and is an important driver for our revenue forecast of server division. We expect System-Z shipments to rise in the near future. Currently we project System-Z units shipped grow from around 21,000 in 2013 to 35,000 by the end of our forecast period.
Growth In Middleware Continues
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 4% year-over-year growth in revenues to $8.1 billion. The key branded middleware reported good growth once again as revenues from this grew by 6%. IBM’s flagship WebSphere software reported double digit growth at 15%. Furthermore, its Rational Suite of software and Social Workforce solutions reported modest growth at 1% and 3% respectively. Since these solutions cater to the growing markets that include mobile, social and security tools, we expect software division to post robust growth in the near future.
New Business Initiatives Drive Growth At GBS
The Business Services division (GBS) contributes over 11% to IBM’s stock value according to our estimates. GBS reported a 4% year-on-year growth in revenue to $4.7 billion, buoyed by growth in Business Analytics (9% growth), Smarter Planet (20% growth) and Cloud (69% growth). Additionally, the company delivered over a $1 billion in cloud revenue during the quarter. As new verticals become a larger part of GBS, they’ll contribute more to the top line performance going ahead.
GTS Revenues To Remain Tepid
The Technology Services division (GTS) accounts for 23% of IBM’s stock value according to our estimates. During Q4, GTS revenues declined by 1% year over year to $9.9 billion. As part of a long-term strategy, IBM sold its customer care business process outsourcing (BPO) services business to focus on high margin verticals.  The divestiture of this business will be completed in Q1 FY14, and will negatively impact GTS revenues marginally in 2014. However, since the company continues to restructure the low margin contracts, its profitability will improve in 2014.
Order Backlog Improves
IBM reported a solid 2% growth in backlog to $143 billion, while the new signings for the company rose by 1%. The primary reason for the improvement in signings was good demand for outsourcing, which witnessed a 15% rise in new contracts. Going ahead, backlog will be negatively impacted due to sale of customer care business. However, we expect the backlog to improve, due to rise in the number of long term high margin contracts. Additionally, we expect that long term contracts will add more stability to IBM’s services revenues in the coming quarters.
We are in the process of updating our IBM model. At present, we have a $234 Trefis price estimate for IBM which is about 30% higher than the current market price.Notes: