International Business Machines (NYSE:IBM) is set to announce its Q4 earnings and full year results on Tuesday, January 21. In the third quarter, the company reported a decline in revenues due both currency headwinds and weaker demand from growth markets. Even as the revenues declined by 4% year on year to $23.7 billion, the company reported 6% growth in net income to $4 billion. While its core software business witnessed mid-single digit growth due to 4% year-over-year growth in middleware revenues, its Global Technology Services (GTS) revenues declined by 1% to $9.5 billion. However, cloud computing and analytics initiatives buoyed Global Business Services (GBS) division revenues, which grew by 4% year over year in constant currency to $4.6 million.
We expect that IBM will continue to report growth for software segment and GBS revenues in Q4. Additionally, we expect order backlog to improve and that will boost revenues in the future. Furthermore, as IT spending rebounds in 2014, we expect the company to report growth in revenues from emerging conomies, which reported a lackluster performance in the previous quarters. However, the GTS revenues will continue to disappoint as the company undertakes contract restructuring.
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Stellar Growth In Middleware To Continue
The middleware and the operating systems divisions are the biggest contributors to IBM’s stock value, together making up nearly 55% of our estimate. Despite a tepid demand in IT, the company has posted double digit-growth in middleware revenues in the last few quarters. The middleware and operating system divisions are important for our valuation of IBM as they have the highest EBITDA margins of almost 47%. We expect the company to report another successful quarter of Middleware revenue growth in the upcoming earnings announcement.
New Initiatives To Bolster GBS Revenues
The business Services division (GBS) contributes over 11% to IBM’s stock value according to our estimates. In Q3, GBS reported a 5% year-over-year growth in revenue to $4.6 billion, buoyed by growth in Business Analytics (8% growth), Smarter Planet (20% growth) and Cloud (70% growth). Additionally, the company delivered over a $1 billion in cloud revenue during the quarter. We expect this trend to power GBS revenues in Q4 as well. As new verticals become a larger part of GBS, they’ll contribute more to the top line performance going ahead.
Revenues From GTS To Remain Tepid
According to our estimates, the Global technology service division makes up 24% of IBM’s stock value. Revenues from this division have contracted over the past few quarter as a result of contract restructuring and decline in outsourcing backlog. We expect this trend continued in the fourth quarter, which likely produced a decline in revenues. However, we expect the outsourcing backlog to improve in 2014 as demand for IT spending picks up, and the company signs more number of long term high margin outsourcing contracts.
Server & Storage Revenues To Decline
The server industry revenues have been declining over the past few quarters. According to IDC, IBM’s market share declined from 27.9% in Q3 2012 to 23.4% in Q3 2013.  We expect the decline to continue in Q4 as well and IBM to report lower revenues for the server division.
However, its high end System-Z server witnessed double digit growth in revenues in Q3, and we expect this to continue in Q4. System-Z demand is on the rise as IBM’s clients continue to demand mainframes with high processing power and big data analytics capability. Therefore, we expect that the high demand for 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 the server division.
We currently have a $235 Trefis price estimate for IBM which is about 25% higher than the current market price.Notes:
- Worldwide Server Market Revenues Decline -3.7% in the Third Quarter as Weak Unix Server Demand Weights on the Market, December 4 2013, www.idc.com [↩]