Shares of International Business Machines (NYSE:IBM) rocketed about 9% higher on Wednesday, one day after the century-old tech giant reported solid third-quarter results and predicted that its years-long revenue slump would end this year. IBM's transformation into a cloud- and cognitive-computing company has tested the patience of investors. That patience now looks like it will be rewarded.
Beyond the headline numbers, IBM management provided some critical details during the company's conference call. If you're an IBM investor, or if you're considering investing in the stock, you need to see these three quotes from CFO Martin Schroeter.
IBM splits its business into two broad categories. The core business, which represents a little more than half of total revenue, is in decline. During the third quarter, core revenue slumped about 8% year over year. These are legacy businesses, some tied to markets in perpetual decline. Still, they remain highly profitable for IBM.
IBM calls the rest of its business "strategic imperatives." This category includes all of IBM's growth businesses, like cloud computing and analytics. The strategic imperatives are growing at a double-digit rate, mostly offsetting declines in the core business.
IBM has made plenty of acquisitions in the past few years to bolster its portfolio of products and services. During the third quarter, though, Schroeter explained that the double-digit strategic imperative growth was almost entirely organic:
Across our segments, our strategic imperatives revenue was up 11% or 10% at constant currency with strong double-digit growth in cloud and security...The revenue performance in the quarter was pretty much all organic. Revenue from our strategic imperatives over the last 12 months was also up 10%, to $34.9 billion, and now represents 45% of IBM.
Nearly half of IBM is organically growing at a 10% rate. That's an impressive feat. It's easy to produce revenue growth by buying up companies. But strong organic growth is a sign that IBM's growth strategy is working.
A security boost
One of IBM's strategic imperatives is security. With large-scale cyberattacks, like the recent Equifax breach, happening more frequently, the cybersecurity market represents a big opportunity for IBM.
During the third quarter, IBM's security revenue surged about 50% year over year, to $700 million. Schroeter provided some details:
This quarter, across our segments, security grew about 50%, driven by our security software solutions and strong demand for the pervasive encryption capabilities in our new z14. The mainframe is a great example of a core platform that we've continually modernized, and now with new capabilities like Machine Learning on z and pervasive encryption, it's been reinvented again for the cognitive and cloud era as well as an ideal platform for blockchain.
IBM began shipping its new z14 mainframe system in September. The z14 features the ability to encrypt all data associated with an application, cloud service, or database without any negative effect on system performance. Each cycle, IBM reinvents the mainframe. The previous new mainframe, the z13 launched in early 2015, focused on enabling the massive number of financial transactions initiated on mobile devices. This time around, security is front and center.
Over the next few quarters, the z14 should continue to drive security revenue and strategic imperative revenue higher.
Ending the streak
IBM doesn't typically provide much in the way of revenue guidance. But with revenue declining on a year-over-year basis for 22 consecutive quarters, the end of this streak is a milestone worth mentioning. Schroeter provided some estimates for fourth-quarter revenue:
As we look to the fourth quarter, as always, we've got a range of scenarios, especially when you consider the typical large transactional base in our fourth quarter. Last year, we increased revenue by $2.5 billion from third to fourth quarter. This year, we'd expect stronger sequential performance due, in part, to the mainframe cycle, so perhaps, $300 million to $400 million more.
IBM expects fourth-quarter revenue to exceed third-quarter revenue by between $2.8 billion and $2.9 billion, driven partially by a strong quarter for the z14. This implies fourth-quarter revenue between $21.95 billion and $22.05 billion compared to $21.77 billion during the fourth quarter of 2016. That's good for year-over-year growth as high as 1.3%.
That doesn't sound very impressive, but it's been a long time since IBM produced any revenue growth at all. The inflection point where the strategic imperatives become large enough to offset declines in the core business is nearly here. Even if growth remains middling, the end of this streak can change the narrative for IBM. The market might start giving Big Blue credit for its turnaround.