IBM is trading lower today following its Q1 earnings report last night. Non-GAAP EPS fell 8% yr/yr to $2.25, which was slightly better than market expectations. Revenue fell 4.7% yr/yr to $18.18 bln, which was light of market expectations. In terms of guidance, IBM reaffirmed EPS of at least $13.90 in 2019. It also reaffirmed FY19 free cash flow guidance of approximately $12 bln.
Cloud & Cognitive Software segment revenue was down 2% yr/yr to $5.0 bln, but actually up 2% on a constant currency basis. Growth was led by cognitive applications, up 2% (up 4% constant currency) and by cloud and data platforms, which was down 2% but up 2% at constant currency). Cloud revenue growth accelerated in the quarter; it was $19.5 bln over the last 12 months, up 10% (up 12% at constant currency). Its Global Business Services segment (includes consulting, application management, and global process services) reported flat growth at $4.1 bln, but it was up 4% adjusting for currency.
While total revenue was down 4.7% yr/yr, IBM makes the point that it was down less than 1% at constant currency as the company faced some pretty stiff currency headwinds with a stronger dollar.
A positive from the quarter was IBM reaffirming FY19 EPS and free cash flow guidance. Also, IBM saw decent margin expansion with operating gross margin up 90bp, driven by both segments. IBM says an improving margin has been a focus for the company.
As we noted in a prior story stock, IBM has been in turnaround mode. A big part of the problem has been that IBM has historically been a hardware-based, large mainframe type business, but the world is changing. Enterprise customers have been moving to the cloud and network virtualization. Also, competition has gotten more intense over the years as younger upstarts have been built from the ground up on cloud, mobility, virtualization etc. Amazon (AMZN) has been very successful with its public cloud computing offering. IBM has had trouble adapting to this new world and its profits have been declining for years.
IBM has taken steps to evolve by focusing more on software, services, systems and they have been marketing themselves as a provider of integrated solutions. Their key areas of focus are cloud, analytics, mobile, cybersecurity, social media etc.
IBM also made a big splash in cloud with its recent announcement that it will acquire Red Hat (RHT), the world's largest provider of open source cloud software for $34 bln. IBM sees the deal as a game-changer. The rationale for the purchase has been that the bulk (80%) of client business still has yet to move to the cloud, held back by the proprietary nature of today's cloud market.
We think the stock is weaker for a few reasons. For one thing, revenue came up light despite IBM facing strong currency headwinds and lapping strong equipment sales in 1Q18. The comments about weakness in Asia were a concern as well. It also was a reminder that IBM's transition to the cloud is still a work-in-progress. Also, after reporting revenue growth in 2Q18, IBM has now posted three quarters of revenue declines in a row. So maybe IBM is not turning the corner as soon as some had been expecting.
IBM made a big cloud bet with its recent deal to acquire Red Hat. The deal is still expected to close in 2H19 and it's not included in guidance. With IBM's huge scale in combination with the largest open source software provider (Red Hat), the combined company seems well poised to tackle this opportunity. However, the benefits from that deal are still a ways off.