Red Hat couldn’t rescue IBM Q3

Global technology stock IBM is looking for growth in Red Hat’s sales, arguing that the software developer will take off with Big Blue’s hardware and sales might behind it.


Cloud-computing software provider Red Hat will contribute more growth to IBM over time.

International Business Machines’ (NYSE—IBM) third-quarter earnings were important because they reflected the July 9th acquisition of Red Hat, a cloud-computing software provider. And, as it turned out, investors were not pleased with the results.

Mind you, adjusted earnings of $2.68 a share were just a penny below the market’s expectations. But investors were more preoccupied with the revenue tally, which came in at $18.0 billion (all figures in US dollars), down by 3.9 per cent from the same quarter, a year earlier.

The hope was that Red Hat would do a better job at offsetting revenue declines in IBM’s legacy businesses—perhaps bringing revenues to $18.3 billion for the quarter. With this hope frustrated, investors knocked the company’s share price down by nearly six per cent in the day following the release of the results.

IBM provides consulting and internet-technology implementation services, cloud, digital and cognitive offerings, and enterprise systems and software. The company serves enterprises of all sizes, and its longest-standing clients are leaders in their industries—the world’s leading financial services institutions, airlines, manufacturers, consumer goods and retail companies.

Q3 revenues, earnings decline

For the three months ended Sept. 30, 2019, IBM made an adjusted $2.4 billion (from continuing operations), or $2.68 a share, compared with $3.1 billion, or $3.42 a share, in the same period of 2018.

Revenues declined 3.9 per cent to $18.0 billion, from $18.7 billion last year.

IBM’s largest segment by revenue, global technology services, which include infrastructure and cloud services and technology support services, saw its revenue decline by 5.6 per cent (down by 4.1 per cent adjusting for currency) to $6.7 billion.

Systems revenues, which include hardware and operating systems software, declined by 14.7 per cent (13.7 per cent adjusting for currency) to $1.5 billion. This reflected the end of the IBM z14 mainframe computer product cycle and the shipment of the new IBM z15 in the last week of September.

Global financing, which includes financing and used equipment sales, earned revenues of $343 million, down by 11.7 per cent (down by 10.7 per cent adjusting for currency). This reflected the wind-down of original equipment manufacturing commercial financing, which is expected to be complete by the end of the year.

Red Hat sales rose 19 per cent

These revenue decreases were partly offset by a 6.4-per-cent revenue increase (up by 7.8 per cent adjusting for currency) at the cloud and cognitive software segment, to $5.3 billion. This segment consists of cloud and data platforms that include Red Hat, cognitive applications and transaction processing platforms. Notably, Red Hat’s sales rose by 19 per cent.

Red Hat has been a part of IBM’s business for only a short time. But, as its operating system and hybrid cloud platform are integrated into IBM’s business, we look for Red Hat to contribute even more meaningful growth over time.

The stock trades at just 10.6 times the $12.79 a share that IBM will probably earn in 2019. The annual dividend of $6.48 a share yields an attractive 4.8 per cent.

IBM remains a stock to buy for long-term growth and income.

This is an edited version of an article that was originally published for subscribers in the November 2019/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

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