IBM Earnings: Revenues From Strategic Imperatives Improves

International Business Machines (NYSE:IBM) posted its Q4 results on January 19th. In line with our expectations, the revenues declined by 2% in constant currency (9% as reported) to $22.1 billion due to declining revenue in the Middleware and Business Services segments. Net income from continuing operations declined by 19% to $4.7 billion in the fourth quarter of 2015. Additionally, the gross margin declined by 160 basis points to 51.7%.

For the FY2015, IBM’s revenues declined by 1% in constant currency (12% as reported) to $81.7 billion and net income from continuing operations  declined by 12%  to $14. 7 billion. However, IBM’s strategic initiatives revenues, which includes cloud, analytics, mobile, social and security, grew by  26% to $28.9 billion or 35% of total revenues. In this note, we explore the segment results for the company.

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Strategic Imperatives Growth Take Center Stage

The company continues to build its portfolio for cloud, analytics, mobile, social and security services through organic and inorganic investment. During the year, IBM acquired seven companies (including Cleversafe, Clearleap, and Gravitant) that augmented its cloud services. Furthermore, it boosted its Watson Analytics business by integrating its organic capabilities with technologies gained in hte acquisitions of Merge, Phytel, and Explorys.

As a result, revenues from these strategic imperatives totaled $28.9 billion to represent 35% of total IBM revenue, up 26% adjusting for currency and the System x divestiture (or 17% as reported). Within these services, Cloud revenues grew to $10.2 billion, an increase of 57% adjusting for currency and the System x divestiture (43% as reported), and business analytics revenue increased by 16% in constant currency (7% as reported) to $17.9 billion.

Software Revenues Decline

The software business is the biggest contributor to IBM stock value, comprising nearly 58% in our estimation.  It includes the branded middleware and other middleware divisions together with the operating systems division. During the quarter and on a constant currency basis, the software segment reported a 6%  year-over-year decline in revenues to $6.8 billion. ^[1] Its key branded middleware segment, which makes up 40.2% of IBM’s estimated value, reported 6% decline in revenues. The primary reason for decline was shift to IBM’s cloud offerings. The Operating System segment reported a decline of 7% to $0.5 billion, due (we suspect) to the increasing use of Linux over proprietary systems.

 GTS Revenues Improve Marginally Due To Softlayer And New Initiatives

The Technology Services division (GTS) accounts for ~15.9% of IBM’s stock value according to our estimates. During Q4, GTS revenues grew by 1% year over year to $8.1 billion. ^[1] During the quarter, GTS integrated technology services reported growth, improving 190 basis points year over year due to several large deals signed over the three months. This quarter, IBM signed 26 services deals greater than a $100 million, and for the full year signed over 70 of these substantial transactions, which is 40% more than last year. Furthermore, Integrated technology services also returned to growth this quarter, with improved performance in cloud, security and business resiliency services. IBM also reported traction for its traditional IT outsourcing that integrates mobility, hybrid cloud and analytics workloads. It also stated that it witnessed double digit growth in its Softlayer business that encompasses outsourcing and the integrated technology service division. The company continues to see clients sign large infrastructure outsourcing deals with embedded cloud and mobile initiatives, creating large-scale hybrid IT environments. The order backlog stands close to $121 billion. ^[2]

New Business Initiatives Drive Growth at GBS Amidst Declining Revenue

The Business Services division (GBS) contributes over 11.5% to IBM’s stock value, according to our estimates. In line with our expectation, GBS reported a 4% year-on-year decline in revenue to $4.3 billion (10% as reported), primarily due to declines in traditional packaged application implementation, especially from in U.S. (its largest market). Moreover, the company continues to be impacted by pricing pressure and client renegotiations, as well as a reduction in elective projects. The company stated that its customers are migrating away from large on-premise ERP projects toward smaller initiatives with cloud, mobility and analytics as main focus, which are contracted in within an X- as-a-service model. However, double-digit growth in digital front office, which includes business analytics (20% growth) and cloud-as-a-service (60% growth), offset the decline in packaged (on-site perpetual license) implementations to some extent. As new verticals become a larger part of GBS, they’ll contribute more to the top line performance going forward. For the quarter, IBM reported that cloud-as-a-service revenues achieved a $5.3 billion in annual run rate, compared to $3.5 billion in Q4 2014.

Server and Storage Division Revenues And Profitability Improve

The server and storage segment, due to its lower profitability, makes up 2.2% of our estimated stock price. During the quarter, revenues for server and storage division increased by 3% in constant currency (a 1% decline as reported) to $2.4 billion. While the revenues for this division were boosted by increased MIPS (million instructions per second) for Z systems and sales of the new Z13 system, storage revenues declined by over 7%. Z system revenues grew by 21% (in constant currency). Additionally, IBM’s Power system, which is focused on high-end Unix and Linux computing, gained traction with clients and revenues improved by 8%. With good adoption in z13 and Power systems, and launch of the remaining P8 based systems in 2016, we expect IBM to post good growth in the coming quarters. However, the Systems margin is driven by the lower mainframe margin, as is typical at this point in the cycle.

We are in the process of updating our IBM model. At present, we have a $154 Trefis price estimate for IBM, which is about 25% higher than the current market price.

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2. Earnings transcript, www.seekingalpha.com [↩]