After 22 consecutive quarters of declining revenue, International Business Machines (IBM 0.18%) is on the cusp of returning to growth. The company will report its fourth-quarter results after the market closes on Thursday, and the launch of its latest mainframe system is expected to make all the difference.
IBM expects the seasonally strong fourth quarter to produce between $2.8 billion and $2.9 billion more revenue than the third quarter. That works out to year-over-year growth of about 1.3%, right in line with the average analyst estimate. It may not seem like much, but a return to even middling revenue growth will be the strongest sign yet that IBM's turnaround strategy is working.
What analysts are expecting
Analysts expect IBM to report fourth-quarter revenue of $22.05 billion on average, up from $21.77 billion in the prior-year period. Adjusted earnings, which IBM calls "operating earnings," are expected to grow to $5.16 per share, up from $5.01 per share in the fourth quarter of 2016.
IBM's full-year guidance for operating earnings is at least $13.80 per share. The company has produced $8.65 per share through the first three quarters of 2017, so it needs at least $5.15 per share in the fourth quarter to hit its target. IBM has beat analyst estimates for earnings for 12 straight quarters, and doing so again will put it above its full-year guidance.
A mainframe boost
IBM announced its latest mainframe system, the z14, in July, and it started shipping it to customers toward the end of the third quarter. Even with shipping so late in the third quarter, mainframe revenue jumped 62% year over year, driving a 14% increase in hardware revenue.
The fourth quarter will enjoy a major increase in mainframe sales as well, if history is any indication. Each new IBM mainframe creates a sales spike as customers upgrade. That spike eventually dissipates, and sales decline once the launch quarter is lapped. The extra few hundred million dollars of mainframe revenue will be the main driver of IBM's fourth-quarter growth, assuming the company doesn't fall short of expectations.
Helping the cause are IBM's strategic imperatives. These are growth businesses, like cloud computing, analytics, and artificial intelligence, that IBM is betting its future on. Over the trailing-12-month period, strategic imperatives generated 45% of IBM's total revenue and grew by 10%. However, this growth was more than offset by slumping sales in the various legacy businesses that comprise the remaining portion of IBM's revenue.
Cloud revenue makes up a significant chunk of that strategic imperatives revenue. Over the past 12 months, IBM's cloud businesses generated about 20% of total revenue, and grew by 25% year over year. The run rate for cloud delivered as a service reached $9.4 billion, also growing by 25%.
2018 may be the year that IBM's growth businesses finally surpass its legacy businesses, both in terms of revenue and in terms of being able to fully offset slumping sales. The company generally doesn't provide full-year revenue guidance, but I'd expect management to mention expectations for 2018 revenue if they see it growing.
The most important report in years
IBM absolutely needs to post revenue growth for the fourth quarter. Anything less will be a disaster for the stock. It's been more than five years since IBM has managed to produce growth. The turnaround story becomes less compelling with each passing quarter.
IBM named a new CFO earlier this month, promoting James Kavanaugh, previously senior vice president in charge of the company's transformation efforts. Previous CFO Martin Schroeter will become senior vice president, global markets.
It will now be up to Kavanaugh to paint a picture of IBM's transformation in the company's quarterly conference calls. A new CFO could mean IBM has reached a new phase in its years-long effort to reinvent itself.