IBM Earnings Preview: Revenues Will Continue To Post Declines

International Business Machines (NYSE:IBM) is set to announce its Q4 earnings on Tuesday, January 20th. In the third quarter of 2014, the company reported a marked slowdown in business due to weak client spending and an anemic demand in the software sector. As a result, the company reported 4% year-over-year decline in revenues to $22.39 billion and 17% decline in net income to $3.5 billion. Excluded from this were the results of discontinued operations that include the x86 server  and microelectronics businesses, which together have revenues of $4 billion.  While its core software business posted 1.6% decline in revenues to $5.70 billion, Global Technology Services (GTS) revenues declined by 2.9% year over year in constant currency to $9.21 billion. Furthermore, its Global Business Services (GBS) revenues declined by 2.2% to $4.49 billion, despite growth in new business initiatives (i.e., cloud, business analytics and big data). IBM’s system and technology division continued to disappoint and reported 15% year-over-year decline in revenues to $2.43 billion, due to product transitions and market disruptions.

Considering the challenging business environment, we expect that revenues across different division will continue to decline in Q4.  However, we are closely monitoring the new signings the services business as this will help us ascertain the order backlog outstanding for 2015. We expect its server and storage division to report another quarter of disappointing results as the company  works to fix this struggling business. Both of its key offerings (Power and mainframe systems) are on the cusp of major product transitions.  Customers have deferred purchases in anticipation and we and other analysts are eager to see to what degree they upgrade and turn this business around.

See our full analysis on IBM

Software Division

The software division is the biggest contributors to IBM’s stock value. Branded middleware, other middleware and OS divisions together make up nearly 63% of our estimated valuation. Branded middleware continues to report good growth on the back of strong market penetration of key offerings, including Tivoli, Rational and Websphere. Both the other divisions (unbranded middleware and OS) have failed to report growth as the product cycles of the associated hardware platforms (Power and Z systems) have yet to gain momentum with new upgrades.

However, demand for enterprise software remains healthy, which should boost demand for branded middleware software. Furthermore, these solutions cater to the growing markets that include mobile, social and security tools. Therefore, we expect the branded middleware division to post growth in Q4 as well as in the near future. However, in this earnings announcement, we are closely monitoring the growth in new licenses for operating system as it will help us to ascertain the demand for its servers in today’s market in greater detail.

Revenues From GTS To Remain Tepid

According to our estimates, the global technology service division makes up 15.6% of IBM’s stock value. Revenues from this division have declined over the past few quarter as a result of contract restructuring and a decline in outsourcing backlog. Furthermore, discretionary IT spending from clients remains weak, which is negatively impacting outsourcing revenues. The decline was further accentuated by the sale of customer care business in 2013, which had a significant contribution to backlog and revenues. We expect this trend to have continued in the fourth quarter, which likely produced a decline in revenues. However, contract restructuring will help the division to post higher profit margins in Q4.

GBS Revenues To Post Another Quarter Of Growth

The global business services (GBS) division contributes over 7.6% to IBM’s stock value according to our estimates. In Q3 2014, GBS reported a 1% year-over-year decline in revenue to $4.5 billion. The company was impacted by pricing pressure and client renegotiations, as well as a reduction in elective projects. We expect this to continue ion Q4 and revenue to be lower. However, its strategic initiatives in Business Analytics (7% growth) and Cloud (50% growth) have done well and we expect this trend to power GBS revenues in Q4.

Server Revenues To Decline

Server and storage division, which was once the cash cow of the company, is witnessing a continuing decline in revenues. The company closed the sale of its x86 server business to Lenovo in Q4. The x86 division caters to the blade and rack server market, which is facing intense competition from the white box (i.e., unbranded) and better-positioned server manufacturers. The remaining server businesses—including z-Systems mainframes, the Power systems, and its range of high-performance computing platforms—each face specific issues.  During the quarter, mainframes were at the trailing end of the product cycle, and the company just this week announced the launch of the  new Z system server. Power systems are confronting severe disruptions in the Unix server market. However, the new Power 8 systems have been released and  should gain some increasing momentum in coming quarters. High-end platforms retain a strong market position and are benefiting from the new Watson initiatives. In short, this challenged division is experiencing a range of issues, though the trends may well be on the cusp of more meaningful improvement in the coming quarters.

We currently have a $204Trefis price estimate for IBM which is about 30% higher than the current market price.

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