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IBM Profit Margins Shrink Again From Shift to Cloud Computing
Chairwoman and CEO of IBM Ginni Rometty speaks onstage at the FORTUNE Most Powerful Women Summit in 2013 in Washington, DC. (Photo by Paul Morigi/Getty Images for FORTUNE)

IBM Profit Margins Shrink Again From Shift to Cloud Computing

The move is taking longer than some investors would like.

(Bloomberg) -- International Business Machines Corp. said profit margins shrank for the fourth quarter in a row, underscoring the technology company’s challenge in shifting to more subscription-based software and cloud services.

Key Points

  • Operating gross profit margin in the third quarter was 48 percent, down 2.1 percentage points from the same period a year earlier. This missed the average analyst estimate of 50.1 percent.
  • Sales were $19.23 billion, down 0.3 percent from the previous year, beating the average analyst estimate of $19 billion. While this is the closest IBM has gotten to revenue growth in more than four years, it’s still the 18th quarter of sales declines.
  • Profit, adjusted for certain items, was $3.29 a share, better than the average analyst estimate of $3.23, according to estimates compiled by Bloomberg.
  • The strategic imperatives group -- which includes businesses such as artificial intelligence, cloud computing and data analytics -- reported revenue of $8 billion in the quarter, up 16 percent from a year earlier.
  • IBM shares fell 3 percent in extended trading to $150.21. They closed little changed at $154.77.

See alsoCloud by the Megawatt: Inside IBM’s Cloud Data Center Strategy

The Big Picture

Since Chief Executive Officer Ginni Rometty took the top post in 2012, investors have been waiting for her to turn the computer services company around and find growth in newer businesses -- like cloud and artificial intelligence -- to offset declines in legacy hardware, software and services units. The move is taking longer than some investors would like. IBM has been spending more on infrastructure and development, as well as on acquisitions, which has dented profitability in recent quarters. The company now has 49 data centers, having added two new ones in the third quarter in South Korea and Norway, Chief Financial Officer Martin Schroeter said on a conference call.

“We have some pretty heavy investment levels going into the cloud and cognitive businesses, and we’ll continue to make those,” Schroeter said in an interview. Less-profitable businesses accounted for more of IBM’s total revenue in the third quarter, which pressured margins, according to Schroeter. The data center investments and this change in revenue sources accounted for more than three-quarters of the margin decline in the quarter, he said.

The Details

  • Revenue in cognitive solutions, which includes much of IBM’s software sales and artificial intelligence products under the Watson brand, increased 4.5 percent to $4.24 billion. Margins narrowed in this segment, due to continued high investment levels, Schroeter said.
  • Sales from technology services and cloud platforms, which include infrastructure software and networking tools, was $8.75 billion, up 2.4 percent.
  • Global business services booked $4.19 billion in revenue, a slight decline of 0.4 percent from the previous year. This sector includes older services, such as business process outsourcing.
  • Sales in the systems segment, which includes mainframes and the operating software that helps run them, declined 21 percent to $1.56 billion.
  • Income from intellectual property increased by $340 million from the previous year, lifting earnings per share by 30 cents, Schroeter said on the call.
  • IBM reaffirmed its full-year profit forecast of at least $13.50 a share, suggesting fourth-quarter profit will be at least $4.30 a share.

Street Takeaways

  • “While headline numbers show a revenue and EPS beat, we note the quality will be an issue,” with earnings per share helped by the unexpected boost in intellectual property income and lower tax rates, RBC Capital Markets analyst Amit Daryanani wrote in a note. Those two factors aren’t good indicators for fundamental business health. With revenue, the concern is that organic growth in newer businesses is stagnating and is buoyed by acquisitions, the analyst also said.
  • “Margins were a little off. You’re going to have that bumpy road when it comes to margins making this shift,” said Dan Morgan, senior portfolio manager at Synovus Securities Inc., which holds IBM stock.
TAGS: IBM Investing
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