IBM Sings the Blues on Mixed Pockets of Strength

Key Points

• Technology giant IBM reaffirmed its 2024 outlook for mid-single-digit growth, crediting its hybrid cloud and AI growth strategy.
• IBM reported a modest Q1 2024 EPS of 8 cents as revenues inched up 1.5% YOY but missed consensus estimates, causing shares to tumble 8.25%.
• The market soured on news of IBM’s $35 per share acquisition of HashiCorp at a 42% premium; the deal is expected to close by the end of 2024.

Once known as "Big Blue," computer and technology sector giant International Business Machines Co. NYSE: IBM shareholders are now the ones with the blues. Shares of IBM fell 8.25% on a not-so-terrible but not-so-great Q1 2024 earnings report, which saw soft revenues of $14.46 billion and missed consensus estimates for $14.53 billion. IBM also spooked investors with its announcement of acquiring multi-cloud automation solutions provider HashiCorp Inc. NASDAQ: HCP for $35 per share in cash, or $6.4 billion -- a nearly 42% premium.

Hybrid Cloud and AI Strategy

IBM has been a leader in artificial intelligence (AI) since the 1990s when it developed the Deep Blue chess computer, and later with the launch of IBM Watson in 2011, an advanced natural language processing and machine learning tool that was named after the company's original CEO, Thomas J. Watson. In 2023, IBM released its generative AI tool Watsonx.ai, which integrated AI into its various services.

IBM also provides hybrid cloud solutions for enterprises to host applications, analyze data and access a multitude of on-demand computing resources.

Steady Blue-Chip Growth

As a hyperscaler, it competes with Amazon Inc.'s NASDAQ: AMZN Amazon Web Services (AWS), Microsoft Co.'s NASDAQ: MSFT Azure, and Alphabet Inc.'s NASDAQ: GOOGL Google Cloud. IBM has evolved into a one-stop technology shop that provides various technology needs from AI, cybersecurity, data analytics, and business intelligence to IT infrastructure and automation. While AI is a steady growth driver, it’s not producing NVIDIA Co. NASDAQ: NVDA-like shock and awe growth results.

Daily Descending Triangle Breakdown 

IBM formed a daily descending triangle breakdown on its Q1 2024 earnings release. The descending trendline formed at $193.28 on April 4, 2024, capping bounce attempts at lower highs. The apex point formed at the intersection with the lower flat-bottom trendline at $181.40. The channel got very thin until the earnings report triggered a gap down to $172.45. The daily relative strength index (RSI) fell below the 30-band to the 23-band. Pullback support levels are at $165.73, $162.35, $157.89 and $154.86.

Earnings: Good, Not Great

IBM reported Q1 2024 EPS of $1.68, beating analyst estimates by 8 cents. Revenues inched up 1.5% YoY to $14.46 billion, falling short of $14.53 consensus estimates. GAAP gross profit margin rose 80 bps to 53.5%. Non-GAAP operating margin rose 100 bps to 54.7%. GAAP income margin was flat at 7.4%. Non-GAAP operating margin rose 130 bps to 11.5%.

Software Is the Growth Driver

By segment, Software saw 5.5% YoY revenue growth to $5.9 billion. Hybrid Platform and Solutions rose 6% YoY. Red Hat revenues surged 9% YoY across three platforms, including OpenShift, Ansible and RHEL. Automation rose 13% YoY. Data and AI revenues rose 1% YoY. Transaction processing grew 3% YoY, while Cybersecurity revenues fell 3% YoY.

The Consulting segment had a 0.2% drop in revenues to $5.2 billion. Business Transformation rose 1%, and Technology Consulting rose 1%. Applications Operations revenues fell 3%. IBM continues to see customers prioritizing big data and technology transformation projects that are focused on growing productivity with analytics and AI. Clients have tightened discretionary spending in Consulting, especially since rates remain higher than expected.

The Infrastructure segment saw revenues fall 0.7% YoY to $3.1 billion. Hybrid Infrastructure saw a 5% YoY jump. IBM zSystems saw a 4% revenue jump, which included a Distributed Infrastructure rise of 6%. Infrastructure Support fell 8% YoY.

HashiCorp Aquisition and 2024 Outlook

IBM reaffirms its outlook for mid-single digits and its full-year 2024 free cash flow (FCF) of around $12 billion. The acquisition of HashiCorp by the end of the year should create a comprehensive end-to-end hybrid cloud platform suitable for the AI era. Although some investors feel the company is overpaying for this deal, IBM expects HashiCorp to be a great addition that will grow Red Hat's hybrid cloud capabilities.

IBM CEO Arvind Krishna noted that the two companies have been strategic partners for a long time and calls HashiCorp a "tremendous fit."  The demand among enterprise clients wrestling with unprecedented infrastructure application expansion across private and public clouds warrants this acquisition sooner rather than later.

Krishna also said that “HashiCorp’s products have wide-scale adoption in the developer community, highlighting the pervasive nature of their technology, used by over 85% of the Fortune 500 and downloaded over 0.5 billion times. The acquisition of HashiCorp builds on IBM's commitment to industry collaboration, the developer community, and open source hybrid cloud and AI innovation.”

Bank of America reiterated its Buy rating on IBM, but lowered its target price to $209 from $220. Although IBM is paying a 42.6% premium to HCP's closing price on April 22, 2024, analyst Wamsi Mohan likes the deal. Wamsi noted that HCP's software provides security, networking and provisioning that will extend Red Hat's capabilities for private cloud. Despite HCP's declining growth, IBM can drive revenue growth and cost synergies across IBM’s much larger customer base.