IBM: Pullback Hasn’t Created Buying Opportunity

Strategic imperatives now count for $30 billion in revenue and we expect this to grow to $40 billion in fiscal 2018 as the firm pursues a hurried acquisition strategy surrounding these services (IBM made six acquisitions in the quarter). We think this revenue growth will help alleviate long-term secular headwinds in the company’s core operations, but we hesitate to make any rash predictions about reinvigorated long-term top line or bottom line growth expectations. We still have concerns about the long-term pricing and rationality of the strategic imperatives market given its highly competitive nature. In addition, all other IT service peers are making similar investments.

Given IBM’s results, we maintain our $145 fair value estimate and narrow economic moat rating. With the stock pulling back to our fair value in after-hours trade, we think investors should seek a wider margin of safety before committing capital to the name.

For the quarter, reported revenue fell 5% year over year to $18.7 billion (declined 2% in constant currency). Notably, strategic imperatives revenue rose 17% in constant currency to $7.0 billion, with cloud revenue up 36% to $2.6 billion and analytics revenue up 9% to $4.2 billion. On the downside, transaction processing software, consulting, integration software, and hardware systems were weak due to the legacy nature of these business lines and/or ongoing restructuring initiatives. We continue to forecast pricing and profit pressure for these businesses.

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