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IBM (IBM -8%) is pulling back sharply despite reporting quite healthy upside results for Q2 last night. IBM had a nice EPS beat and revenue grew 7.7% yr/yr to $16.98 bln, which was above expectations. Notably, this was IBM's strongest yr/yr growth since 2Q22. We suspect F/X tailwinds helped with a weaker dollar. We were a bit disappointed IBM did not guide for next quarter revs like it did last quarter. However, IBM reaffirmed FY25 revenue growth of at least 5% CC, while also slightly raising its FCF outlook to exceed $13.5 bln.

• The Q2 outperformance was led by Software and Infrastructure as demand remains high for technology that improves productivity, reduces costs, and fuels innovation. However, IBM did say, while not a major factor overall, geopolitical tensions are prompting a few clients to move cautiously. US federal spending was also somewhat constrained in 1H25, but IBM does not expect it to create long-term headwinds.
• As has been the case in recent quarters, its Software segment was the star of the show with revenue up +10% (+8% CC) to $7.39 bln with strength across key categories of Red Hat (+14% CC), Automation (+14% CC), Data (+7% CC) and Transaction Processing (-2% CC). Software is now about 45% of its business with 80% recurring revenue.
• Infrastructure segment revenue was up big at +14% (+11% CC) to $4.14 bln. Investors were eager to hear about the Q2 launch of its next generation z17 mainframe. z17 is IBM's most advanced mainframe yet. It features the new Telum II processor, delivering more than 450 bln AI inference operations per day with millisecond latency. That means AI models can run directly on transactional workloads with no external servers needed. The launch has gone well and is seeing early strength as AI use cases are resonating strongly with clients.
• Consulting segment revenue was up +3% (flat CC) to $5.31 bln. This segment has been weak in recent quarters as clients have been delaying decision-making and there have been pricing pressures. However, IBM was slightly more positive this time, saying this segment stabilized in 1H25 and its backlog remains healthy, up 4% yr/yr, despite the challenging pricing environment.

IBM reported impressive upside in Q2 and its z17 launch is going well. So, why is the stock lower? First, we think IBM's decision not to raise FY25 top line guidance, despite strong upside in Q2 and with the F/X tailwinds, is being viewed as a disappointment. Second, IBM provided cautious commentary about client spend generally, and federal spend, in particular. Also, its Consulting segment remains a weak spot. And finally, the stock has made a strong run since its Q1 report, so it looks like investors are using Q2 results as an excuse to lock in some profits.