IBM is trading -4% lower today after reporting Q4 results last night despite a slight beat on EPS and revenue. IBM has been in turnaround mode. It was the second worst Dow performer in 2017 (better than only GE). 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 as 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. The company has been making progress.
Turning to the Q4 report, IBM reported non-GAAP EPS of $5.18, which was up from $5.01 last year. Revenue rose 3.6% year/year to $22.54 bln. Both EPS and revenue were slightly above market expectations. What's notable here is that this was the first quarter that IBM reported revenue growth in nearly six years.
Breaking down the numbers a bit, cloud revenue in Q4 rose 30% YoY to $5.5 bln. For all of 2017, cloud revenue was $17.0 bln, including $9.3 bln delivered as-a-service and $7.8 bln for hardware, software and services to enable IBM clients to implement comprehensive cloud solutions. To put that $17 bln in perspective, it's up from $7 bln just three years ago. Revenue from analytics increased 9% while revenue from mobile increased 23% and revenue from security increased 132%.
On the call, IBM said its Systems results were terrific across IBM Z, Power and storage. This was its first full quarter with the z14 and with pervasive encryption. This reflects the strong demand for its pervasive encryption in IBM Z, as the company reinvents that platform for the most contemporary workloads.
It also had a good performance in managed security services within its GTS business and in security software. Over the last several years, IBM has been making investments and shifting resources, embedding AI and cloud into more of what it offers. In Cognitive Solutions, IBM said it had good growth in several areas, including security, IoT and its industry-based systems like Watson Health and Watson Financial Services, though the company was disappointed by the performance in a few of its more traditional analytics offerings.
So why is the stock down despite some pretty good numbers? While the market was happy to finally see revenue growth again after years of declines and there was decent revenue upside relative to expectations. However, the revenue upside was more from mainframe server sales (which were quite strong) and not from cloud sales. Investors had been hoping there would be more upside for cloud.
Another issue is that service margins were seen as disappointing. During Q&A, IBM was asked about the erosion in operating margins in both GBS and in Technology Services & Cloud Platforms. IBM says part of this was due to product mix. IBM had a terrific Systems quarter, which is high margin but it's not as high margin as its software business. Also, there was some shortfall on productivity.
In sum, investors seem to be disappointed in the Q4 results. One thing to consider is that the stock had run about 9% since the beginning of 2018, heading into this report. So expectations were running pretty high, perhaps too optimistic as it turns out. The hope was that Q4 might be that turning point quarter for the turnaround. But it sounds like the turnaround is going to take some more time.