Report
Andrew Lange
EUR 850.00 For Business Accounts Only

Morningstar | IBM’s Mixed Performance Continues; Red Hat Remains Beacon of Opportunity; Shares Near Fair Value

IBM’s second-quarter result followed a similar pattern to its first quarter with a mixed bag performance across its portfolio. The cloud & cognitive software and global business services, or GBS, businesses continued to perform reasonably well while the global technology services, or GTS, and systems businesses lagged. We still see some positive signs for the services businesses such as GBS and GTS, where digital transformation services and portfolio optimization remain key levers. Within GBS, IBM’s consulting strength is a notable strong suit, meanwhile we think the GTS business could see some positive momentum with the recent addition of Red Hat and the improved hybrid cloud position of the company. To reiterate our first quarter comments, we see the marked slowdown in the Systems business as cyclical, based on the underlying product lifecycle of the mainframe platform. With the firm’s financial performance tracking mostly to expectations and management reiterating their full year financial guidance (excluding the impact of Red Hat), we maintain our $158 fair value estimate and narrow economic moat rating. With shares down slightly afterhours, the firm remains in 3-star territory and we’d suggest a wider margin of safety before committing new capital to the name.

For the quarter, reported revenue fell 4.2% year over year to $19.2 billion (1.6% in constant currency). We saw some moderation in cloud revenue growth during the quarter with the firm posting as-a-service annual run rate revenue growth (in constant currency) of 7% year over year relative to 15% last quarter, and total cloud revenue growth of 8% (last 12 months) compared with 12% in the prior quarter. GBS, GTS, and systems were the primary drivers of this cloud growth moderation.

The hybrid cloud boost IBM will receive from the Red Hat acquisition will be supportive and at least provide IBM with a fighting chance versus other cloud providers. We see Red Hat as an open source sales catalyst for IBM across its own (and competitors) infrastructure-as-a-service, platform-as-a-service, and hosted private cloud environments. While IBM held to its full year financial view for continuity of comparison in the second quarter, the firm is expected to hold an investor briefing on Aug. 2, 2019 to formally announce its financial outlook with Red Hat included. At this stage, the acquisition is expected to be accretive to free cash flow in the first year, and accretive to non-GAAP operating earnings per share by the end of the second year after closing.

In terms of IBM’s second quarter margin performance, non-GAAP gross margin expanded 100 basis points to 47.4% and its non-GAAP pretax income margin dipped 30 basis points to 16.6%. The pretax margin dip was influenced by workforce rebalancing as the firm restructures for higher-growth initiatives. We see a midterm opportunity to improve the profitability of IBM and believe higher-value services combined with productivity and global scaling efforts will aid in this margin expansion.
Underlying
International Business Machines Corporation

International Business Machines provides integrated solutions and products that utilize data, information technology, capability in industries and business processes. The company has five segments: Cloud and Cognitive Software, which provides a range of software offerings; Global Business Services, which provides consulting, systems integration, application management and business process outsourcing services; Global Technology Services, which provides project services, managed and outsourcing services, cloud-delivered services, and technical and IT support services; Systems, which provides technology and service; and Global Financing, which provides client financing, among others.

Provider
Morningstar
Morningstar

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.

Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.

We have operations in 27 countries.

Analysts
Andrew Lange

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