Key Takeaways

  • Adjusted EPS was $2.58 vs. the $2.54 analysts expected.
  • Revenue exceeded analysts' expectations.
  • Cloud revenue grew 19% YOY.
  • RedHat led strong performance in IBM's cloud business.

What Happened

IBM reported adjusted EPS that beat analysts' expectations for Q3 2020. Revenue was also higher than expected. Both adjusted EPS and revenue, however, were down compared to the same quarter a year ago. IBM's total cloud revenue grew YOY, led by strong performance from RedHat. The company noted that the recent spinoff of its managed infrastructure services business will help IBM to focus on its open hybrid cloud platform and AI capabilities.

"The strong performance of our cloud business, led by Red Hat, underscores the growing client adoption of our open hybrid cloud platform," said CEO Arvind Krishna.

(Below is Investopedia's original earnings preview, published October 14, 2020)

What to Look For

International Business Machines Corp. (IBM) this month announced a major restructuring aimed at focusing on what the company sees as a $1 trillion growth opportunity in hybrid cloud computing. The move comes as the company aims to capitalize on rising demand for cloud computing services as the work-from-home economy expands amid the COVID-19 pandemic.

The pandemic thus far has caused a sharp slowdown in the global economy and investors will be looking to see how it has affected IBM when the company reports earnings on October 19, 2020 for Q3 2020. Analysts expect modest year-over-year (YOY) declines in both earnings and revenue. IBM on October 8 released preliminary numbers that indicated its Q3 revenue will be slightly better than estimates, but still down from a year earlier.

Investors also will focus on another key metric in the Q3 results: IBM's cloud revenue. Growth in the company's cloud revenue is outpacing other parts of its business. There are no consensus estimates for IBM's cloud sales for Q3, but its growth has accelerated dramatically in recent quarters, rising by 31.3% in Q2 2020 even as overall revenue declined.

IBM's shares have lagged the broader market over the past year, but the underperformance has only widened since the onset of the pandemic. The company's stock has mostly traded sideways since the end of April, while the rest of the market has continued to rise after bottoming out in the latter half of March. Shares of IBM have provided a total return of -7.5% over the past 12 months, a stark contrast to the S&P 500's total return of 18.6%, as of October 13, 2020.

One Year Total Return for S&P 500 and IBM
Source: TradingView.

Despite reporting Q2 2020 earnings that exceeded analysts' expectations in mid-July, the stock continued its sideways momentum in the following months. Adjusted earnings per share (EPS) fell 31.3% on a 5.4% drop in revenue, compared to the same quarter a year ago. Hampered by the adverse economic impact of the pandemic, it marked the largest decline for either metric in at least four years.

It also marked the fourth straight quarter of YOY declines in adjusted EPS and the second consecutive quarter of YOY declines in revenue. Results also were weak for Q1 2020, when adjusted EPS fell 18.1% to its lowest level in any quarter for at least four years. Revenue declined 3.4% compared to the year-ago quarter.

Analysts expect adjusted EPS to decline 5.3% in Q3 2020 as revenue falls 3.0%. Analysts estimate that 2020 full-year adjusted EPS will fall 15.2% as revenue declines 4.1%. It would mark the largest annual decline in either metric in at least the past four years.

IBM Key Metrics
  Estimate for Q3 2020 (FY) Q3 2019 (FY) Q3 2018 (FY)
Adjusted Earnings Per Share ($) 2.54 2.68 3.42
Revenue ($B) 17.5 18.0 18.8
Cloud Revenue ($B) N/A 5.0 4.6

Source: Visible Alpha

One of the only bright spots for IBM recently has been growth in its cloud computing revenue. Cloud computing refers to the delivery of various computing services via the Internet. It allows companies to gain on-demand access to computer resources like data storage, servers, software applications, and more without having to purchase and set up the necessary computing infrastructure on their own premises. This can reduce costs while increasing productivity and efficiency.

IBM has made several moves over the past year to bolster its cloud computing business. Last year, it paid about $34 billion to acquire Red Hat, a company specializing in open-source software, including cloud-related software. IBM's latest restructuring will accelerate that move. The announced plan involves spinning off into a separate company most of its slow growth, legacy IT services business, with $19 billion in sales and 90,000 employees. This will free IBM to focus more aggressively on cloud computing as it faces tough competition from Amazon.com Inc.'s (AMZN) Amazon Web Services, Microsoft Corp.'s (MSFT) Azure, and others.

IBM's cloud revenue encompasses all cloud-related revenue generated across its reportable segments. As mentioned, it grew 31.3% in Q2 2020, the largest YOY increase in cloud revenue since Q1 2017. Cloud sales grew 19.7% in Q4 2019 and 19.3% in Q1 2020. Despite that strong growth, cloud revenue still only comprises about 34% of total revenue. That's why total revenue declined last quarter in spite of strong revenue growth generated by cloud-related sources. IBM management, and also many investors, expect the cloud to make up a fast-growing share of IBM's total revenue. That growth is crucial if IBM is to have any chance of reversing years of anemic revenue and earnings growth.