Please ensure Javascript is enabled for purposes of website accessibility

Another Revenue Decline Expected for IBM

By Timothy Green - Updated Jan 20, 2020 at 12:06PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

IBM's fourth-quarter results won't be pretty, but the long-term picture looks better with Red Hat in the mix.

International Business Machines (IBM -2.88%) will report its fourth-quarter results after the market closes on Tuesday, Jan. 21. The report will close out a challenging year, with revenue down in 2019 as the company continues to transform itself. The acquisition of Red Hat is part of that transformation, but it won't help IBM's numbers much in the fourth quarter.

What happened last time

IBM's third-quarter report was a mixed bag: Earnings beat analyst expectations, but revenue slumped by more than expected.

Metric

Q3 2019

Change (YOY)

Compared to Average Analyst Estimate 

Revenue

$18.0 billion

(3.9%)

Missed by $190 million

Non-GAAP (adjusted) earnings per share

$2.68

(21.6%)

Beat by $0.02

Data source: IBM.

Adjusted for currency and divestitures, revenue was down just 0.6% in the third quarter.

IBM completed the acquisition of Red Hat last July, so its third quarter numbers did include Red Hat's results. However, IBM was able to recognize only a portion of Red Hat's standalone revenue because of accounting rules related to deferred revenue. While Red Hat would have generated nearly $1 billion of revenue as an independent company, IBM was able to recognize just $371 million of revenue.

While Red Hat's revenue contribution was only partial, IBM did have to recognize all of Red Hat's expenses. That's one reason for the steep decline in earnings.

Like its overall results, IBM's segment results were a mixed bag:

Segment

Revenue

Change (YOY), Constant Currency

Cloud and cognitive software

$5.3 billion

8%

Global business services

$4.1 billion

2%

Global technology services

$6.7 billion

(4%)

Systems

$1.5 billion

(14%)

Data source: IBM.

What analysts are expecting

IBM is expected to report small declines in revenue and adjusted earnings per share in the fourth quarter:

Metric

Average Analyst Estimate

Change (YOY)

Revenue

$21.63 billion

(0.6%)

Non-GAAP earnings per share

$4.69

(3.7%)

Data source: Yahoo! Finance.

Once again, IBM will be required to include all of Red Hat's expenses but only a portion of its revenue. Revenue will get a boost from the z15 mainframe, which began shipping at the very end of the third quarter. The tech giant typically enjoys four to five quarters of strong year-over-year growth in mainframe revenue after each major refresh.

Red Hat can drive growth in the long run

IBM should be able to muster some revenue growth in 2020, thanks to Red Hat and the new mainframe. On a stand-alone basis, Red Hat grew its revenue by 20% in the third quarter. With an annual revenue run rate of roughly $4 billion, that's around $800 million of annual growth if IBM can maintain that rate.

IBM's Global Center for Watson IoT in Munich, Germany.

Image source: IBM.

IBM can accelerate Red Hat's growth by selling its software to existing customers with little or no Red Hat exposure. IBM sees a $1 billion annual revenue opportunity for every 5% of its large client base that adopts Red Hat.

The benefit of acquiring Red Hat was on display when IBM announced a 10-year, $1.1 billion deal to overhaul Spanish bank Banco Sabadell's IT systems. Banco Sabadell is moving to a hybrid cloud environment, and Red Hat's OpenShift platform is a key ingredient.

IBM's results will continue to be muddled by revenue recognition rules related to Red Hat in the fourth quarter and into 2020. Earnings will be under pressure this year, but IBM expects EPS to begin to benefit from Red Hat in 2021. Also in 2021, Red Hat is expected to add around $1 billion to IBM's free cash flow.

IBM made a big bet on the hybrid cloud when it paid $34 billion for Red Hat. We'll see over the next few years whether that gamble pays off.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

International Business Machines Corporation Stock Quote
International Business Machines Corporation
IBM
$134.38 (-2.88%) $-3.99

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
349%
 
S&P 500 Returns
122%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/18/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.