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IBM (IBM -6%) is trading lower after reporting Q3 results last night. It reported nice EPS upside, but revenue rose just 1.5% yr/yr (+2% CC) to $14.97 bln, which was a bit light. However, IBM reaffirmed FY24 free cash flow guidance at "above $12 bln." It also said it expects Q4 CC revenue (not comparable to consensus) to be consistent with Q3.

• The Software segment was the star of the show with revenue up +9.7% (+9.6% CC) to $6.5 bln with a reacceleration in Red Hat +14% and continued strength in transaction processing. Software is now nearly 45% of total revs, up from the high 20's in 2018. IBM says this is a testament to innovation and repositioning its portfolio. Its recurring revenue base, which is about 80% of annual Software revenue, continues to deliver strong growth. ARR for hybrid platform and solutions now stands at $14.9 bln, up 11% yr/yr. Also, this quarter marks the 5-year anniversary of the Red Hat acquisition. Red Hat has doubled in size since the deal was announced.
• Turning to its Consulting segment, revenue was down -0.5% yr/yr (-0.2% CC) to $5.2 bln, which was at the lower end of internal expectations. Technology spending remains strong. However, a pause in discretionary spending is impacting IBM's Consulting unit. IBM cited an uncertain macro environment (geopolitical issues, US election, changing interest rates, inflation). At the same time, clients are reprioritizing their IT budgets to prepare for generative AI.
• While demand for large digital transformations remains solid, IBM's overall signings declined for the second consecutive quarter. Despite the weak current demand environment for Consulting, IBM says it's well-positioned to capture growth from generative AI. It continues to build a solid generative AI book of business with about $1 bln of new bookings in Q3.
• Its final segment is Infrastructure, which saw sales decline -7.0% (-6.7% CC) to $3.0 bln, reflecting product cycle dynamics. Hybrid infrastructure was down 9%, and within that, IBM Z revenue declined 19% in what is now the 10th quarter of z16 availability. The silver lining is that the z16 program continues to exceed prior cycles, delivering revenue growth in 8 of the last 10 quarters. Distributed Infrastructure revenue was down 3%, with product cycle dynamics impacting its Power business.
• IBM says it has made solid progress in transitioning its portfolio to a higher growth, higher margin business and that it is well positioned heading into 2025. Software revenue growth has accelerated throughout the year, and this should continue in Q4 as IBM expects low double-digit growth for Software, led by Red Hat growth in the mid-teens. IBM expects Q4 Consulting revenue performance to be similar to Q3.

The stock is trading lower despite the EPS upside, decent guidance and robust Software segment results. Infrastructure was weak, but that was expected given that we are now into the tenth quarter since IBM's z16 launch. We think IBM's comments about macro pressures and seeing a pause in discretionary spending from its Consulting clients are mostly responsible for today's pullback.

Also, the stock has been a beast (+40% since early June), trading at new all-time highs earlier this month as investors have been focusing more on IBM's AI exposure. As such, sentiment was likely pretty high heading into this report, so it does not take much to convince them to book some profits.