International Business Machines (NYSE:IBM) posted its Q1 results on April 16. The company reported a decline in revenues due to cross currency headwinds and low demand for its servers. While the revenues declined by 3.9% year on year to $22.484 billion, net income declined by 21.4% to $2.38 billion. Diluted GAAP EPS also declined by 15.4% to $2.29 during the quarter, primarily due to workforce rebalancing that impacted the bottom-line by $870 million.
Its core software business posted low-single digit gains, primarily due to 5% year-on-year growth in branded middleware revenues. Furthermore, Global Business Services (GBS) revenues grew by 2% year over year in constant currency to $4.5 billion, buoyed by growth in its cloud computing and analytics initiatives. However, its Global Technology Services (GTS) revenues declined by 1% to $9.3 billion. IBM’s system and technology division continued to disappoint and reported 23% year-over-year decline in revenues to $2.4 billion, due to product transitions and market disruptions.
Server And Storage Division Drags Revenues And Profitability
Server and storage division, which was once the mainstay of the company, is witnessing a continuing decline in revenues. During the quarter, revenues for this division declined by 23% to $2.4 billion.
While System-Z, Power Systems and System-X revenues declined by 40%, 21% and 17% respectively, storage revenues declined by 23%. The hardware business has been under pressure for a number of quarters. The System-Z mainframe business is in the latter quarters of a product cycle, though its market position remains strong. The Power Systems business is focused on high-end Unix and Linux computing. Customer investment here has migrated to bladed and white-box data center environments, more than off-setting contribution of the high performance end of the market. Finally, with the sale of the x86 business to Lenovo pending, the performance of the Systems-X business has faltered. And with the sales of servers down so sharply, the storage business is under pressure as well. Management is right-sizing the remaining businesses and, once the sale of the x86 business is completed, the server and storage business will be smaller and more profitable.
Branded Middleware Boosts Middleware Revenues
The software business, which includes the Middleware division together with operating systems division, is the biggest contributor to IBM stock value and makes up nearly 55% of our estimate. During the quarter, the software segment (middleware and operating systems combined) reported 2% year-over-year growth in revenues to $5.7 billion. The key branded middleware reported good growth once again, as revenues from this grew by 5%. IBM’s flagship WebSphere software reported double digit growth at 12%. Furthermore, its Tivoli and Rational Suite of software reported modest growth at 7% and 2% 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.
Restructuring Impacts GTS Revenues
The Technology Services division (GTS) accounts for 22.5% of IBM’s stock value according to our estimates. During Q1, GTS revenues declined by 1% year over year to $9.3 billion. As part of a long-term strategy, IBM sold its customer care business process outsourcing (BPO) services business in Q4 to focus on high margin verticals.  The divestiture of this business was completed in Q1 FY14, and negatively impact GTS revenues marginally. However, since the company has been restructuring the low margin contracts, its operating profit margins improved by 90 basis points to 47.6% in Q1 2014.
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 2% year-on-year growth in revenue to $4.5 billion, buoyed by growth in Business Analytics (5% growth) and Cloud (50% growth). As new verticals become a larger part of GBS, they’ll contribute more to the top line performance going ahead.
We are in the process of updating our IBM model. At present, we have a $230 Trefis price estimate for IBM which is about 20% higher than the current market price.Notes: