IBM CEO Krishna: ‘M&A Is An Important Part Of Our Growth Methodology’

‘This year we have got a big one coming [with HashiCorp]. … Part of the discipline is also making sure that we kind of digest them at the right rate and pace and put them into our global market distribution engine,’ says IBM CEO Arvind Krishna on the company’s second-quarter earnings call.

IBM exceeded expectations in its artificial intelligence, software and infrastructure businesses during the second quarter and, while consulting remained hit by high inflation, Big Blue’s top executives view the segment as essential to dominating the emerging AI market.

These were some of the main points IBM Chairman and CEO Arvind Krishna conveyed on the Armonk, N.Y.-based tech giant’s quarterly earnings call Wednesday, reporting the company’s performance for the three months ended June 30.

Krishna said on the call that he remains optimistic on enterprise technology spending. Although the war in Ukraine, the conflict between Israel and Palestine and this period of greater inflation, interest rates and wage inflation have “gone longer than most people expected” and have been factors in IBM’s weaker consulting business results, an end to the inflationary period’s toll on the business is in sight.

“Is this going to go on for another six months? Likely,” he said. “Is it going to go on for another year? I’m not so sure. But we have got to get through the second half [of the year]”.

IBM Second-Quarter 2024 Earnings

With the second-quarter results, IBM largely maintained its full-year 2024 financial guidance. It raised its expected full-year free cash flow to more than $12 billion, citing the pending sale of QRadar to Palo Alto Networks as a particular factor in increasing expected cash flow. The deal should close by the end of IBM’s third quarter.

IBM also raised its software growth for the year to high single digits, with IBM CFO Jim Kavanaugh telling analysts on the call that generative AI traction was a factor.

Consulting should grow in low single digits for the year due to customer spending pressures, plus flat growth in infrastructure, he said.

IBM AI And Consulting

Krishna said that IBM Consulting, No. 6 on CRN’s 2024 Solution Provider 500, “remains below model,” citing interest rates and inflation as factors hitting spending and deal timing in this segment.

IBM has seen customers shifting spending from other consulting areas to focus on AI, but “we don't actually believe it’s cannibalistic,” Krishna said.

As time goes on and people move from AI experimentation to scaling AI, Krishna believes the work “will turn into accretive and additive” for consulting, but it isn’t clear when that will happen.

“We are optimistic about the medium- and long-term vector of consulting,” Krishna said. “We do see that this is going to become a tailwind over time, at least for us.”

Kavanaugh told analysts on the call that IBM is “very pleased with the early momentum that we’ve gotten with our book of business around GenAI” in technology and open-source innovation, saying that the GenAI consulting book of business doubled quarter to quarter.

“We’re above our own expectations right now,” he said.

IBM revealed on the call that its AI book of business has exceeded $2 billion since the launch of Watsonx a year ago. A quarter of that is in software and 75 percent is in consulting signings.

Consulting is important in the early part of the cycle to establish IBM “as the strategic provider of choice for enterprises as they’re going through what we like to call ‘digital transformation 2.0’ with GenAI,” Kavanaugh said. Consulting could hold multiplier opportunities for IBM.

“Everyone is looking for who is going to be their strategic provider and partner,” Kavanaugh said. “IBM has both technology and consulting, which is a unique and powerful combination to help clients navigate this technology transition,” as IBM did with the adoption of the internet and globalization.

With more than $1.5 billion “book of business in the first 12 months, which, by the way, is in excess of the ramp we saw play out with hybrid cloud and Red Hat, we’re off to a pretty good start,” he said.

Consulting reported revenue for the quarter of $5.2 billion, up 2 percent year over year ignoring foreign exchange.

Within this segment, business transformation revenue grew 6 percent year over year ignoring foreign exchange, especially due to finance and supply chain transformation. Technology consulting grew 1 percent due in part to app modernization services. Application operations fell 2 percent due in part to weakness in on-premises custom app management.

Kavanaugh said that IBM saw $5.7 billion in signings, “driven by solid demand for large engagements across finance and supply chain transformation, cloud modernization and application development.”

Continued discretionary spending constraints hit IBM’s small engagement performance and backlog realization in the quarter.

IBM’s backlog grew 5 percent year over year. Its trailing 12-month book-to-bill ratio remained more than 1.15.

Going After Smaller AI Models

Krishna said that IBM has open-sourced its Granite AI models as a way to bring in more developer users.

“There are a lot of enterprise reasons why people will still do business with us, but the open-source nature … allows us to expand that market into the millions of developers who do run Linux on their own machines or their corporate machines or their laptops,” Krishna said. “And they can go experiment … and either give it back to the community or actually reserve it for their enterprise.”

The vendor has also been investing in smaller AI models and more specific ones, such as a model for programming languages and a model for business languages, to reduce the cost of implementing AI and the consumption of compute, network and memory.

“They are one-tenth—or less than that—of the size of extremely large models,” he said. “But you can look at the leaderboard, they perform quite as well as the largest models.”

Small models and open-source tools can drop the cost of AI down by 90 percent and more, Krishna said. “For what it can do, that is a very attractive proposition.”

IBM continues to add AI capabilities across its stack, including in automation products, Red Hat, transaction processing and IBM z inferencing, Krishna said. Hybrid cloud has also provided AI model deployment flexibility across multiple environments with data sovereignty.

AI also promises to boost IBM hardware and infrastructure offerings for getting the most out of the emerging technology, Krishna said.

Kavanaugh said that IBM research and development spending grew 9 percent in the first half of the year related to AI, hybrid cloud and infrastructure.

More Acquisitions

Krishna said to expect more AI capabilities in HashiCorp cloud infrastructure automation tools once the acquisition is complete. IBM reiterated that despite scrutiny from the Federal Trade Commission, it expects to close the deal by year’s end.

Red Hat Ansible working with HashiCorp Terraform “will simplify provisioning and configuration of applications across hybrid cloud environments,” Krishna said.

Kavanaugh revealed that the recently acquired Apptio business saw annual recurring revenue growth “in the midteens.”

IBM ended the quarter with $16 billion in cash, perhaps setting it up for more acquisitions. Krishna noted that valuations “are reasonably rich,” seeing multiples between six and 10 for companies in the public market and much smaller in the private market, saying he was “very pleased” with the price for the Software AG assets of StreamSets and webMethods.

“They’re not outrageous, I would say, like they had become in parts of late 2020 and 2021,” Krishna said. “M&A is an important part of our growth methodology … This year we have got a big one coming. … Part of the discipline is also making sure that we kind of digest them at the right rate and pace and put them into our global market distribution engine.”

IBM Infrastructure

IBM’s infrastructure segment revenue grew 2.7 percent year over year ignoring foreign exchange.

Within this segment, hybrid infrastructure, which includes the IBM z line and distributed infrastructure, grew 6 percent. IBM z revenue grew 8 percent, outperforming prior cycles, Kavanaugh said.

Distributed infrastructure increased 5 percent, with growth in storage offerings and Power10 SAP HANA use cases. Infrastructure support fell 3 percent.

“Our clients are facing increasing demands for workloads given rapid business expansion, the complex regulatory environment and increasing cybersecurity threats and attacks,” Kavanaugh said. “IBM z addresses these needs with a combination of cloud-native development for hybrid cloud, embedded AI at scale, quantum safe security, energy efficiency and strong reliability and scalability.”

IBM has seen its mainframe millions of instructions per second (MIPS) grow threefold from an installed perspective, Kavanaugh said. More than 80 percent of customers are growing MIPS on the mainframe.

“That was a very different picture when you dial back five, seven years ago,” he said. “We've taken that from a mid-single-digit portfolio to now capitalizing on the stack economics of our mainframe execution and moved that to a low single digit. … We feel very confident that we can continue growing this. And that’s why we’re investing and bringing out new capabilities.”

IBM Second Quarter In Depth

For the quarter, IBM brought in $15.8 billion in revenue, up 4 percent year over year ignoring foreign exchange.

Software revenue grew 8.4 percent year over year ignoring foreign exchange, bringing in $6.7 billion.

Within the software segment, transaction processing (TPP) grew 13 percent year over year ignoring foreign exchange.

IBM hybrid platform grew 6 percent year over year ignoring foreign exchange. This segment’s annual recurring revenue is $14.1 billion, Kavanaugh said, up 9 percent year over year.

Red Hat grew 8 percent year over year. Annual bookings growth accelerated to more than 20 percent, Kavanaugh said. OpenShift annual bookings were up 40-plus percent. Red Hat Enterprise Linux (RHEL) and Ansible saw double-digit growth.

Automation was up 16 percent. Data and AI fell 2 percent. And security increased 3 percent.

IBM’s stock traded at about $189 a share after hours Wednesday, up about 3 percent.