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International Business Machines Corp.’s 2020 fortunes may hang on how well Red Hat keeps contributing to Big Blue’s growing cloud business, analysts said Wednesday.
The company surprised Wall Street with a slight gain in revenue driven by its cloud and systems segments in an earnings report Tuesday afternoon, ending more than a year of declines, and forecast adjusted 2020 earnings of “at least $13.35” a share.
IBM IBM, +2.85% shares were last up 3.2% at $143.67, following an intraday high of $145.79. In comparison, the Dow Jones Industrial Average DJIA, +0.10% rose 0.2%, the S&P 500 index SPX, +0.18% gained 0.3%, and the tech-heavy Nasdaq Composite Index COMP, +0.37% advanced 0.5%.
Evercore ISI analyst Amit Daryanani, who has an in-line rating and a $145 price target, said the main investor focus for 2020 is how sustainable the contributions of Red Hat and mainframes will hold up for the year. IBM acquired Red Hat for about $34 billion in a deal that closed in July.
“The print was better vs. feared especially for Red Hat and mainframe revenues, but we think the EPS and FCF guide is lower quality vs. expected and the ramp-up in EPS could prove overly aggressive especially if the cyclical benefits from the mainframe cycle ease-up,” Daryanani said.
Wedbush analyst Moshe Katri, who has a neutral rating and a $155 price target, called IBM’s “beat and raise” quarter one of low quality.
“IBM’s annual weak YOY booking metrics relative to peers’ strength could point to ongoing market share losses, potentially hindering the company’s ability to grow its service businesses in CY20 and CY21,” Katri said.
“The bottom line, IBM’s financial metrics continue to be negatively impacted by ongoing revenue/pricing cannibalization of legacy software/services as services delivery utilize [social, mobile, analytics and cloud]-related technologies and as enterprises continue to change the way they buy software,” Katri said.
MoffettNathanson analyst Lisa Eliis, who has a sell rating and a $121 target price, was a little more blunt. Calling Red Hat and mainframes “two notable bright spots” in IBM’s earnings report, Ellis said that “nearly everything else, however, was remarkably weak.”
“IBM’s all-important Cloud & Data Platforms segment (12% of revenues) down-ticked to ~4% growth in the quarter (pro forma for Red Hat), from ~6% in 3Q19, which, given the strong performance of Red Hat, indicates anemic performance in the rest of that segment, which houses many of IBM’s other Cloud products (e.g., IBM Cloud Paks and PaaS offerings), implying that so far Red Hat is not helping the broader IBM gain ground in Cloud,” Ellis said.
Stifel analyst David Grossman, who has a buy rating and a $169 price target, said IBM’s global technology services, or GTS, segment remains an “Achilles heel” for the company.
“Both the mainframe cycle and RHT acquisition anniversary in 2H20, which suggests the turnaround of GTS is critical (and sufficient) to sustaining the current growth trajectory (1-2% cc organic growth),” Grossman said. “Our positive thesis (rerating) assumes GTS begins to improve in 2H20, enhancing confidence in the sustainability of positive revenue growth, even if modest, and FCF to support the dividend.”
GTS revenue came in at $6.95 billion in the fourth quarter, while the Street had expected $7 billion.
Of the 20 analysts who cover IBM, four have buy or overweight ratings, 14 have hold ratings and two have sell or underweight ratings. Following the four price target hikes and one price target cut from analysts, the stock has an average target price of $148.76, up slightly from $148.53 the day before, according to FactSet data.
