Red Hat Still a Bright Spot for IBM Amid COVID-19

IBM IBM reported a third consecutive quarter of revenue declines in its third quarter results, although top-line results were above our former expectations--as Red Hat continued to be a lone growth driver--and IBM’s non-GAAP earnings were in line with CapIQ consensus. Earnings came over a week after IBM announced its plans to spin off its managed infrastructure services businesses. Nonetheless, little new information was given on the spin-off expected for 2021. Still, we continue to think the spin-off is beneficial more in optics--as it should allow IBM’s overall top-line growth to look better by divesting the large but dwindling segment. IBM continued to refrain from publishing an outlook for the quarter or full year, but we expect the final quarter will see strong sequential growth due to IBM’s seasonality despite another expected quarter of annual declines. We’ve also increased our expectations for the year, leading us to raise our fair value estimate for the narrow-moat name to $125 per share from $120. Shares are down 3% to $122 per share upon the news, implying that IBM’s stock is fairly valued, in our view.

In the third quarter, total revenue declined by 3% year over year to $17.6 billion. IBM’s cloud & cognitive software revenue rose by 7% year over year, benefiting from a mix shift away from transactional software, which was disproportionately dragged by COVID-19. In the segment, Red Hat revenue increased by 17% year over year, propping up overall segment growth. Global technology services revenue decreased by 4% year over year as a result of IBM’s hardware product cycle and pandemic related weakness. Global business services revenue decreased by 5% year over year due to project delays caused by COVID-19 and, relatedly, enterprises staying cautious about discretionary spend. Systems revenue decreased by 15% year over year, which is in line with the cadence of typical product cycles. Financing revenue decreased by 20% year over year.

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