IBM Q4 2023 Earnings Preview: 5 Things To Know

AI has likely brought “a very modest contribution to date,” according to one investment firm’s report.

IBM’s artificial intelligence offerings. The performance of its consulting wing. And updates on Red Hat and Apptio.

These are some of the likely topics to come up when the Armonk, N.Y.-based vendor reports earnings for the fourth fiscal quarter on Wednesday. The quarter ended Dec. 31.

Multiple investment firms debated in recent reports when IBM’s AI and generative AI (GenAI) offerings will add meaningful revenue for the vendor, with a seeming consensus around the earliest AI revenues coming form IBM Consulting’s work with customers – a potential good sign to IBM solution providers also finding work helping customers navigate adoption of the emerging technology.

IBM Q4 Earnings

In a January report, investment firm Bernstein said it expects “largely fine” results from IBM, expecting quarterly revenue of about $17.4 billion, above the consensus of $17.2 billion. That would be about 3 percent higher year over year.

For the fiscal year, Bernstein predicts $63.6 billion in revenue compared to the consensus $63.5 billion amount. It predicts 2.8 percent revenue growth and 90 basis points of year-over-year margin improvement and net income of about $8.8 billion for the year.

For fiscal year 2024, Bernstein predicts $63.6 billion in revenue, ahead of $63.5 billion consensus. It predicts $9.6 billion in net income, up 8 percent year over year, and between $10 billion and $10.5 billion in free cash flow.

However, the $10.5 billion free cash flow target “is not a slam dunk,” Bernstein warned, with potential weaknesses in consulting book-to-bill, transaction processing revenue growth and overall corporate IT spending.

“Even if the bridge from net income to free cash flow is not fully transparent, IBM appears to be on track to at least land within striking distance,” according to the Bernstein report.

Here’s more of what you can expect on IBM’s quarterly earnings call Wednesday.

AI’s Revenue Contributions

The Bernstein report said that AI has likely brought “a very modest contribution to date,” with the IBM book of business – revenues in the quarter plus bookings, including third-party AI offerings – related to generative AI in the "low hundreds of millions." About half of that came from consulting, the other half from software. And IBM leaders have said that AI wins are usually consulting-led.

“We continue to believe that it is early in the AI story, with enterprises still in the exploratory phase,” according to the Bernstein report. “It remains to be seen how incremental AI budgets will be, and to what extent IBM will be able to sustainably differentiate itself from its peers in terms of its AI capabilities and overall AI business.”

The firm wants IBM leaders to clarify who is building foundational models on its platform and who are its key AI partners.

Melius Research managing director Ben Reitzes told CRN in a recent interview that his firm covers IBM as part of a basket of publicly traded companies “front and center of the AI debate,” including Google, Microsoft, Cisco, Oracle, Adobe and Snowflake. Its consulting wing and the quality of its technology are part of IBM’s differentiators.

“We feel that AI is creating an opportunity for IBM to regain its relevance especially in highly regulated industries where they have an excellent reputation for risk management, compliance and other aspects,” Reitzes said. “Even with the risks around AI, we thought that IBM had some special characteristics on a global basis. … IBM has divested a lot of businesses that were slower growing, more commoditized or cyclical, and focusing now more on software. … They've been able to retain some of the historical strengths, which is the reputation in the enterprise and strength in heavily regulated industries and it's made them very well-positioned for AI.”

In a December report form Melius, the firm said that IBM could see 5 percent software growth in 2025 and again in 2026, “which could prove quite conservative if IBM is able to gain significant traction with the watsonx platform for enterprise AI.”

“All told, we believe that Generative AI initiatives in software can add over $400mm in revenue upside to consensus estimates for IBM software by 2025,” according to the report.

Multiple news outlets reported that investment firm Evercore ISI upgraded IBM to “outperform,” citing IBM’s position to capitalize on AI tool deployment through software and consulting and eschewing consumer-facing AI tools such as ChatGPT from Microsoft-backed OpenAI and Google Bard. The analyst said AI could lend itself to a $1 billion IBM Consulting practice.

Multiple outlets also reported that Jefferies called IBM a “hold” stock in January because of revenue growth below peers

IBM Hardware, Transaction Processing

Despite IBM usually guiding its transaction processing business – principally made of the company's mainframe software offerings and accounting for 12 percent of total revenues and about 29 percent of total profits in 2022 – to decline mid-to-high single digits, it grew 7 percent in the first quarter, 10 percent in the second and 5 percent in the third with price increases and “good transactional performance,” according to Bernstein.

It’s one of IBM’s highest margin offerings with about 40 percent operating margins. But “TPP’s significant profit contribution, the sustainability of TPP’s price increases and expected growth into FY 24 are key issues for investors,” according to Bernstein.

IBM’s infrastructure business could face a tough year with a new mainframe not expected until late in the year or even early 2025, according to Bernstein.

A January report form Morgan Stanley said that surveys of resellers and chief information officers in the fourth quarter of 2023 showed “an upward revision to 2024 enterprise Hardware budgets, with growth now expected to accelerate by 40bps Y/Y (to 1.7% Y/Y).”

“PCs, Servers and Storage all screen positively, with Gen AI emerging as an incremental HW budget tailwind,” according to the report.

In the survey, IBM services “continue to show structural improvements, but remain mixed overall,” according to the report, with the big winners including Dell, HP and Logitech. “IBM still screens as a cloud budget share donor.”

The vendor’s “IT services spending intentions improved to all-time record vs. peers in 4Q23,” according to the report. “While IBM used to be the most at risk of IT services vendor consolidation, this is no longer the case.”

Still, “broader spending on IT Services remains a key risk, as a net 3% of Services experts expect to spend less (vs. more) on IT Services in 2024 vs. 2023,” according to Morgan Stanley.

Red Hat, Apptio, Software

Bernstein predicted about $120 million in revenue contribution year over year from Apptio and about $100 million from Octo in the quarter. IBM bought Apptio last year for about $4.6 billion. And IBM announced the Octo acquisition at the end of 2022.

A possible headwind to IBM’s year ahead is that Red Hat no longer benefits from deferred revenue write-downs and sees underlying year-over-year growth further moderate, according to Bernstein.

Bernstein said that “portfolio moves - particularly the Kyndryl spin-off and Red Hat acquisition, but also smaller acquisitions like Apptio - have improved IBM’s normalized revenue growth rate from a -2% decliner to a ~2% grower.”

Morgan Stanley expects growth for IBM subsidiary Red Hat to accelerate in 2024 with IBM still losing long-term budget share due to cloud migrations.

“VARs expect RHT growth of +1.7% Y/Y in 2024, up from +0.3% in 2023,” according to Morgan Stanley. “While 1.7% growth is relatively modest, we are encouraged by growth re-accelerating after a deceleration in 2023. In addition, a net 12% of CIOs expect IBM to be the largest budget share donor due to the shift to the cloud over the next 3 years, 2 points below legacy tech peers and a 3 point deterioration Q/Q. … This is something we will be watching moving forward.”

In a December report from Melius Research, the firm said that “while IBM missed out on upside from SaaS and the cloud, the company has pivoted with the Red Hat acquisition and Kyndryl divestiture.”

Under the leadership of CEO Arvind Krishna, SVP Software Rob Thomas and SVP Consulting John Granger, IBM is streamlining communication and integration across these groups to maximize cross-selling opportunities in software, according to Melius.

The firm called recent performance in the approximately $26 billion software business “encouraging.”

“We estimate that the new offerings noted above, stability in transaction processing and 8-10% growth in Red Hat will help Software grow 5.5% in FY24 to $28B ($400mm above consensus), picking up especially in H2,” according to Melius.

IBM Consulting

The Bernstein report said that IBM Consulting “has historically struggled, with revenue growth lagging peers at -0.2 percent per year from 2010-2019 vs. Accenture at 7.8% and a broader sample of peers at 10.9 percent.”

But since Arvind Krishna became CEO in 2020, this wing’s “results have improved and are tracking ahead of targets and peers … including a ~2% acquisition contribution,” according to Bernstein. “Much of IBM's Consulting recent strength has been driven by success in its Strategic Partnerships with ISVs and hyperscalers - which accounted for >40% of Consulting revenues last quarter, and we believe accounted for more than 100 percent of Consulting's revenue growth.”

Bernstein will watch for “incremental commentary on the Consulting strategic partnerships, especially as peers continue to highlight a soft demand environment,” according to the report.

The Morgan Stanley report noted that in its latest quarterly VAR and CIO survey, “IBM also continues to outpace Accenture in quality of strategic consulting. … for the 2nd consecutive survey,” with elevated IBM Consulting discounting a possible reason.

In a December report, Melius Research said that IBM can potentially do better than Accenture because of its proprietary technology. Its $200 million in AI bookings is “likely to surge in upcoming quarters,” according to the report.

“IBM should continue to narrow its discount to ACN as investors see growth rates normalize and consulting pull through a higher margin software business,” according to the report.

IBM consultants will help customers with “picking large language models, prepping data, creating apps and monitoring performance.”

“As its software modules for AI become increasingly relevant, IBM consultants should have an advantage vs. peers, especially in regulated industries and government backed sectors,” according to Melius. “IBM’s consulting mix is differentiated vs. Accenture due to its Red Hat and Automation related consulting businesses, while having less exposure to slower growing Cloud projects linked to AWS.”

Melius predicts an 8 percent growth in consulting in 2024, about $600 million above consensus, which puts growth at 4.8 percent.

IBM Partnerships A Factor

In his interview with CRN, Reitzes praised the job of Rob Thomas, IBM’s senior vice president of software and chief commercial officer, and the size of IBM’s partner ecosystem.

“What's good is their partnerships across with many of the application software providers that are going to be tapping into the potential of AI,” he said. “Not just Microsoft, where they have a partnership, but they partner with Salesforce. … They partner with Workday. They partner with SAP. And we wouldn't be surprised if they continue to broaden partnerships with rivals. … They have an AWS cloud offering that is still scaling. And I think that they're going to work better with AWS technologies over time as well. And they can take advantage of that.”

IBM could find a position as a neutral technology stack in AI for customers concerned about offerings from the likes of Microsoft and Google – ironically, taking a similar position that subsidiary Red Hat holds in enterprise technology, he said.

“The world does need a cloud-neutral vendor in the AI party who has your best intentions in mind with regard to the apps, and then allows you to pick models and clouds that are right for your cost optimization over the long term,” he said. “And they're uniquely positioned to do that. … The more they partner with the major clouds, the better. … While they had shown aspirations to become one of the hyperscalers of choice years ago, that obviously has come and gone. And utilizing your strengths of being a more cloud neutral party could be a real advantage here. There's a real need for it.”

He cautioned that IBM still has a lot of work ahead of it, he said.

“They still have to prove it,” he said. “It's been hard for the investment community to come to grips with the fact that AI could be a great opportunity for them. And what we're seeing is better execution as we've gone throughout (2023). And hopefully it results in them achieving the higher end of some of their revenue metrics by the end of next year. We think it can.”