Key Numbers
IBM Q2 2024 Earnings: Consulting Growth Opportunity Remains a Concern
IBM’s Q2 2024 earnings present a mixed picture, with some areas of strength, notably in the Software segment and areas of concern, particularly in Consulting. The company’s financial performance exceeded expectations in some key metrics, leading Morgan Stanley to adjust its CY24 estimates slightly upwards. However, the broader sentiment remains cautious, with the price target modestly increased from $179 to $182, reflecting a 12% higher Free Cash Flow (FCF) base but an unchanged valuation multiple of 17x.
Key Takeaways
- IBM believes choosing the right AI model size is crucial for success in scaling AI cost-effectively. While large general-purpose models are good for starting AI use cases, smaller “fit-for-purpose” models are essential for more cost-effective AI strategies at scale. IBM’s Granite models, ranging from 3B to 34B parameters, can be ~90% less expensive than the largest models.
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IBM believes the combination of right-sized open models, hybrid cloud flexibility for deployment across environments, leveraging enterprise data, and its software and consulting capabilities provides a differentiated approach as clients look to productize and scale AI vs. relying solely on large models from hyperscalers.
- The recurring software and services focus is expected to drive more consistent performance, but challenges remain in reaccelerating growth. Upside risks include success in General AI and further acquisitions, while execution and AI cannibalization present downside risks.
- Growth in Consulting was cut to low single digits from mid-single digits, reflecting weak discretionary spending. IBM acknowledged that General AI consulting is cannibalistic to other consulting projects, which raises concerns about the future growth trajectory of this segment.
What’s Significant
The software segment emerged as a strong performer, generating $6.74 billion, while consulting revenues slightly declined by 0.9% to $5.2 billion. The infrastructure sector experienced a modest growth of 0.7%, bringing in $3.65 billion, whereas financing revenues saw an 8.3% decrease, amounting to $169 million.
IBM’s remains strategically focus on integrating AI across its business operations. In the software domain, the company leverages AI in its suite of automation products, such as Apptio and Watson X Orchestrate. The impending acquisition of HashiCorp is expected to further enhance this integration.
The company continues to prioritize its hybrid cloud strategy, with a strong emphasis on AI, recognizing the importance of deployment flexibility and data sovereignty for clients.The burgeoning interest in generative AI is reflected in IBM’s business, with the company reporting a substantial book of business related to this technology.
Financial Performance:
Revenue and Earnings: IBM posted a solid Q2 beat, with revenue and EPS estimates moving 1% higher based on the quarter’s performance. The revenue now stands at $63.2B, with EPS at $10.16.
Software Segment: The beat was primarily driven by the Software business, specifically Transaction Processing (TP), which materially outperformed expectations.
Gross Margins: Gross margins outperformed across all segments, contributing positively to the company’s overall financial health.
Free Cash Flow: There were positive surprises in FCF, with CY24 revenue guidance reiterating at the low end of mid-single-digit revenue growth in constant currency (~3.5% Y/Y) and FCF guidance increasing to “greater than $12B.”
Business Highlights:
Revenue Mix Shift: The revenue guidance for CY24 remains unchanged at the low end of the 3%-5% range in constant currency, but there’s a shift towards revenue streams considered less secular, with Consulting’s outlook reduced significantly.
Red Hat and Software Performance: Red Hat’s growth slowed to 8% in constant currency, with expectations for acceleration in the second half. The overall software growth was supported by acquisitions and TP growth.
Overall, the investor sentiment appears cautiously positive. IBM’s strategy aligns with its enterprise focus and leverages its strengths in open-source (through Red Hat) and developer ecosystems. However, investors are likely looking for concrete results and market traction to validate this approach fully in the competitive AI landscape. Some investors might also worry about the potential loss of IP through open sourcing.