International Business Machines Corporation (NYSE:IBM) came up during Jim Cramer’s October 1 review of the Dow Jones Industrial Average’s third-quarter performance. Despite his favorable view of the company, he said its quarterly disappointment required patience. He stated:
In the end, I think the best lessons from the third quarter came from the 30 stocks in the Dow Jones Industrial Average, which finished down 2.7%… Dow’s losers, worst for last… IBM missed its quarter and fell 22%. You know my rules: you miss a quarter, you gotta wait a quarter. I like IBM, but rules are rules.
Cramer was quite bullish on the stock during a July episode.
Red Hat and Data Software Offer Areas of Strength
International Business Machines Corporation reported uneven second-quarter performance, but several businesses continued to expand. Software revenue increased 5% to approximately $7.8 billion, including 11% growth at Red Hat and 19% growth in Data. Distributed Infrastructure revenue rose 37%, with Power and Storage building an order backlog of nearly $500 million. These results show that the company’s difficulties were not uniform across its portfolio.
IBM also expanded its data software business through the March acquisition of Confluent. At completion, the company said Confluent’s platform served more than 6,500 enterprises, including 40% of the Fortune 500. Its data-streaming capabilities add to IBM’s offering for businesses developing AI applications that require current operational information. Cash generation provides another source of support. IBM produced approximately $4.8 billion in free cash flow during the first half and maintained its expectation that full-year free cash flow would increase by about $1 billion from 2025. The company is building a bigger software business, but can its balance sheet keep up?
Delayed Deals and a Demanding Recovery
International Business Machines Corporation’s July 14 shareholder letter offered a specific explanation for its shortfall. CEO Arvind Krishna said customers redirected spending toward servers, storage, and memory ahead of anticipated price increases. He also acknowledged that IBM did not respond quickly enough and that numerous large deals failed to close when expected. This makes the timing and execution of future transactions an important test of the recovery.
The final results showed IBM Z revenue falling 42% and Transaction Processing revenue declining 8%. Total revenue increased just 1% to approximately $17.2 billion. Operating, non-GAAP EPS nevertheless rose 5% to $2.93, distinguishing the revenue disappointment from an across-the-board earnings decline. Management’s updated full-year outlook called for constant-currency revenue growth of 4% to 5%.
International Business Machines trades at approximately 17.4x forward earnings, versus 13x for Accenture plc (NYSE:ACN), a direct competitor in consulting and technology services. However, the company trades at a significant discount from its sector median. IBM’s software and infrastructure businesses limit a company-wide comparison, but its higher multiple means the stock is not clearly inexpensive relative to that services competitor.
More Hedge Funds Held IBM in the Second Quarter
The number of International Business Machines Corporation shareholders as per Insider Monkey’s hedge fund database increased to 74 in the second quarter from 59 in the preceding quarter. AQR Capital Management was the company’s top hedge fund holder with nearly 2.69 million shares as the firm raised its holdings by 43% in Q2. Additionally, Marshall Wace LLP raised its stake in the company by 492% to 1.7 million shares. Meanwhile, 2.65% of the public float was sold short, a relatively small share.
IBM’s software growth and cash-flow outlook provide reasons to monitor the stock. Cramer’s decision to wait puts the focus on whether the next quarter highlights better deal execution and a recovery in the businesses responsible for the shortfall.
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