Earnings Outlook: IBM is still counting on Red Hat for growth as coronavirus spreads

Earnings Outlook: IBM is still counting on Red Hat for growth as coronavirus spreads

13 Apr    Finance News

This article is part of a series tracking the effects of the COVID-19 pandemic on major businesses, and will be updated. It was originally published on April 13.

As COVID-19 turns the global economy upside down, many corporations are rethinking their tech spending for the year, but International Business Machines Corp. doesn’t seem to be changing its plans.

IBM IBM, -0.28% is focused on integrating its huge Red Hat acquisition this year, and trusting in that cloud-software business to provide the growth that Big Blue needs as it breaks in a new chief executive. Analysts covering IBM were already divided on the tech giant’s prospects for 2020, however, debating how sustainable contributions from Red Hat and mainframes would hold up for the year.

Now, with COVID-19 spreading, there is even more doubt, as businesses slash spending plans that could have involved IBM. While some analysts believe cloud software companies are better positioned than most enterprise vendors during the pandemic as businesses scramble to adapt to the work-from-home paradigm, other analysts who follow cloud software are seeing signs of deals drying up.

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JMP Securities analyst Patrick Walravens, who covers the cloud-software sector but not IBM, recently told MarketWatch that many software deals that had been placed before the pandemic have fallen victim to the uncertain business climate created by the coronavirus.

“We’re seeing pipelines disappear,” said Walravens. “Salespeople look at the deals they thought were going to close this quarter and those deals are no longer going to happen.”

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Certain business customers, however, like telecom, health care and pharmaceuticals, have been slower to drop spending, Walravens said. While IBM counts those sectors as software customers, it also counts on retailers and airlines as customers — industries that were hit hard by the pandemic — so analysts will likely want to dig down into IBM’s customer base.

IBM’s other businesses could face similar dynamics, as sales estimates for all five of IBM’s core business units have declined in the past three months, according to FactSet. The company does have experience with recessions, however, having lived through a few in its long history.

IBM has a “solid track record as a defensive holding during prior recessions given business critical nature of products/solutions,” Evercore ISI analyst Amit Daryanani said in a March note.

What the numbers are saying

Revenue: Analysts surveyed by FactSet expect IBM to report first-quarter revenue of $17.8 billion, down from the $18.18 billion reported in the year-ago period. Cloud and cognitive software sales are still expected to rise nearly 6% to $5.33 billion from a year ago.

Earnings: Back in late January, IBM forecast adjusted earnings of “at least” $13.35 a share for 2020. At the time, analysts had forecast $13.28 a share, but now expect $12.70. For the quarter, analysts expect $1.82 a share, down from $2.25 a share a year ago.

Stock movement: Over the first quarter, IBM shares fell 17%, while the Dow Jones Industrial Average DJIA, -1.38% — which counts IBM as a component — dropped 23% and the S&P 500 index SPX, -1.01% fell 20%. Of 20 analysts that cover IBM, six have overweight or buy ratings, 12 have hold ratings, and two have sell ratings, along with an average price target of $139.28.

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What the company is saying

April 10: IBM said it was holding its annual stakeholder meeting April 28 online rather than in Louisville, Ky., in response to the COVID-19 pandemic.

April 6: Arvind Krishna started as the new chief executive, after IBM announced at the end of January that Ginny Rometty was stepping down.

April 3: IBM said it was making cloud and AI resources available to researchers and doctors to help with finding a treatment for COVID-19.

April 2: In a Securities and Exchange Commission filing, IBM said it was lending computing power to the White House Office of Science & Technology and the Department of Energy to help researchers under the COVID-19 High Performance Computing Consortium.

March 25: IBM said it was offering tools through The Weather Channel and associated apps to track cases of the virus around users.

March 3: Chief Financial Officer James Kavanaugh, in a Morgan Stanley presentation, made no mention of the spread of COVID-19 or China, focusing the discussion on its cloud and cognitive business driven by Red Hat.

What analysts are saying

• “COVID-19 and ensuing macro uncertainty” could weigh on IBM’s guidance provided earlier in the year, and growth in IBM’s non-Red Hat businesses “remains inconsistent.” — Evercore ISI analyst Amit Daryanani, who has an in-line rating and a $130 target price on IBM. Daryanani said he was sticking with his rating until potential changes to the company’s long-term strategy and financial targets were more clear under its new CEO. Daryanani held out that Krishna could inspire a stock re-rating much like when Satya Nadella took over as CEO of Microsoft Corp. MSFT, +0.22% back in 2014.

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