IBM announced its Q3 2023 results on October 25, 2023. As a normal course, we started to pen a research note to document our observations from the quarterly announcement. But something stopped us in our tracks. The timing of the results was both interesting and intriguing.
Interesting because, for the first time in years, IBM stock is the most searched-for and talked about stock. Compared to its peers, it’s performing far better and has been edging on 52-week highs after a long spell. Here’s some more context. This trend of the IBM stock making news was also seen in 2022 when IBM beat other large-cap technology peers, generated a total of USD 752 million in free cash flow, and paid a total of USD 1.5 billion in dividends. Lest we forget, 2022 was a rough year for most technology stocks, and investors took a sell position instead of a buy. The only exception was IBM, which continued to trade well.
The story is no different in 2023. Most, if not all, equity analysts have qualified it as a trending stock. To put numbers to it, the stock has recovered 8.6% since the announcement of the quarterly results – at the time of penning the note, the stock was trading at USD 148.83 compared to USD 137.08 as of October 25, 2023. See image 1 below for more details. Of course, what the stock trajectory will be hereon depends on both internal and external factors, including (but not limited to) geopolitical tensions, de-dollarization, competitive announcements and much more.
Net net, there’s consensus that IBM stock under Arvind Krishna, who has pivoted the company’s focus on Hybrid Cloud and Artificial Intelligence, is performing well and has a solid recall amongst investors.
Image 1: IBM Stock Performance | Source: Yahoo! Finance | Date of capture: Tuesday, November 7, 2023
On a side note, since we are talking about the performance of the IBM stock, we should call out that we are not an investment advisory firm, and this is not a stock recommendation. Please do your research before investing in stocks. The information shared herein are facts about IBM at the time of writing. Although most of you already know, it is better that we clarify (our legal team tells us that it is best we do it!), so here it goes. Greyhound Research is an Enterprise IT Research, Advisory, Consulting and Education firm that provides reports, trackers, toolkits, and decision-making tools to help organizations in their digital transformation journey and innovation agenda. With the legal talk done, let’s discuss IBM’s Q3 2023 results.
Street cheer apart, the timing is also intriguing since it’s been two years since IBM’s formal spin-off of Kyndryl. With 7-8 quarters of running the business since the spin-off, we believe it’s a decent time to review and assess its impact. More importantly, it is also a good timeframe to review if IBM, under the leadership of Arvind Krishna, is landing on the vision of the “New IBM”.
Since we are on the “New IBM” topic, it is worthwhile to spend a few minutes jogging through this vision and how it differs from the erstwhile IBM that we all know well. Of course, many of you know of this change already, but many still don’t fully understand what “The New IBM” stands for and how it’s taking shape. Hence, this attempt to offer more context that we hope will help technology decision-makers better grasp the company.
The image below does a great job of summarising the new focus areas of the “New IBM”. Here are ten things about the “New IBM” we at Greyhound Research believe are worth calling out. Of course, there are many more, but we keep the list at ten for easy reading and understanding.
Image 2: IBM Business Units & Offerings | Source: IBM
1/ IBM has steered clear from Infrastructure Services, also known as Global Technology Services or GTS, in the erstwhile IBM. This business was spun off as Kyndryl. For reference, Kyndryl and IBM were officially separated on November 4, 2021. Post separation, Kyndryl had annual revenues of nearly USD 19 billion, 4000+ customers and operations across 60+ countries. Since we are on the topic of GTS, its other partner-in-crime, IBM Global Business Services, or GBS, has been rebadged as IBM Consulting and focuses on forward-looking areas like Business Transformation and Application Operations.
2/ The acquisition of RedHat is now front and centre to nearly all business units across the company and acts as the foundation for its efforts on the Hybrid Cloud offerings. However, it’s important to note that RedHat continues to function as a separate entity from IBM.
3/ IBM now has three key business units it currently operates: IBM Consulting, IBM Software, and IBM Infrastructure. The financials are also reported along these segments. At the end of FY22, IBM Software contributed USD 25,037 million to the total revenue. This translates to 41.4% of the company’s total revenue. This is followed by IBM Consulting, which totalled USD 19,107 million at the end of FY22, contributing 31.6% to the company’s coffers. Lastly, IBM Infrastructure accounted for 25.3% of the company’s revenue in FY 22; this translates to USD 15,288 million.
Since the Q3 2023 results are topical, it’s worth pointing out that while IBM Software continues to contribute the maximum (42.3%) to the company’s total revenues, the contribution of IBM Consulting has grown to 33.6%. Of course, these numbers will change as and when IBM releases its Q4 2023 results, but YTD numbers are proof enough of the company putting the focus where it matters the most – its software business.
While additional analysis on the topic is shared later in the research note, images 3 and 4 below highlight some of the numbers as discussed above and the relative contribution of each of the business units and offerings.
Image 3: IBM Segment Revenue | Source: IBM’s SEC Filings
Image 4: IBM Segment Contribution | Source: IBM’s SEC Filings
4/ IBM Software operates under two key categories – one, Hybrid Platforms and Solutions that includes IBM Security, Data & AI, Automation and RedHat and two, Transaction Processing that includes Customer Information Control System and storage software, and analytics and integration software running on IBM operating systems (e.g., DB2 and WebSphere running on z/OS).
5/ IBM Consulting operates under three key categories – one, Business Transformation, which includes Strategy, process design, system implementation and operations services to improve and transform key business processes. Two, Technology Consulting includes skills to architect and implement cloud platforms, including Amazon, Microsoft and IBM, and application modernization for hybrid cloud with Red Hat OpenShift. Notably, IBM Consulting houses the largest Red Hat practice across all key consulting firms. Three, Application Operations that include application and cloud platform services required to operationalize and run cloud platforms.
6/ IBM Infrastructure operates under two key categories – one, Hybrid Infrastructure, offers platforms including zSystems and Distributed Infrastructure, including power hardware and operating system, storage hardware, IBM Cloud IaaS, and OEM asset recovery service. Two, Infrastructure Support that offers maintenance for IBM products and other technology platforms.
7/ IBM’s recent announcement of WatsonX, IBM’s Enterprise AI platform, is undoubtedly the most promising offering for enterprises that do not wish to use offerings like ChatGPT by OpenAI, among others. In addition to its AI models, IBM announced earlier this year that it plans to host Meta’s Llama 2-chat 70 billion parameter model in the watsonx.ai studio. Furthermore, the company also announced its intent to work with VMware to offer WatsonX, its generative AI platform, in the on-premises world. As we finalize this research note, IBM has made two big announcements to top these efforts. One is a $500 million venture fund to invest in AI startups focused on generative AI for the enterprise. Two, it decided to acquire Manta Software, which it believes will complement data and AI governance capabilities. Not sure if anyone still needs more convincing that IBM is gearing itself to rule the Enterprise AI space in the coming years.
8/ A team of Infrastructure Support Services from the erstwhile IBM was retained as part of the new IBM under its Infrastructure business unit. What they do is now increasingly visible under a new team called the Client Engineering Team. Of course, this team also borrows from other teams within IBM, spanning product, consulting, client servicing and others. The intent of the team, as described by IBM, is a no-cost multi-disciplinary team to jointly innovate and rapidly prove solutions to business opportunities by leveraging IBM hybrid cloud and AI technologies. Per IBM, this team isn’t the same as the existing client servicing team. Instead, it focuses on offering a technical solution – akin to a minimal viable product or an MVP – that can then be rolled out for production as SaaS to the cloud environment of the client’s choice.
9/ IBM now puts a significant onus on the ecosystem it works with. This is visible in its efforts to work with System Integrator Partners, Software and SaaS Partners, Developers and, most importantly, providers in the Public Cloud and Enterprise Infrastructure space. IBM’s partnership with Amazon Web Services (AWS) has been the most talked about recently. Greyhound Research believes this partnership resembles IBM’s deep relationship with SAP, which dates well over 50 years. That said, we at Greyhound Research believe IBM’s approach to its cloud, IBM Cloud, is far more pointed and strategic than previous times when the company hoped to replace other hyperscalers from its key accounts.
10/ As IBM reshapes, reorganises, and relaunches itself for the world of Hybrid Cloud and AI, it has acquired companies over the past few years to plug gaps in its portfolio. In addition to its latest commitment to investing in AI start-ups (point 7 above), the company has completed eight acquisitions in 2023. This has cost the company a total of USD 5,033 million. See image 5 below for the list of acquisitions completed in 2023.
Image 5: IBM List of Acquisitions in 2023 | Source: IBM’s 2023 SEC Filings
Greyhound Research has also been tracking IBM’s acquisitions regularly, and in addition to the above, below is a list (image 6) of 23 acquisitions since 2020. This does not include IBM’s biggest acquisition, i.e. RedHat, since it dates to 2018. A glance at the list, and it’s hard to miss the company’s clear focus on Hybrid Cloud and Artificial Intelligence. Take a look:
Image 6: IBM List of Acquisitions 2020-2022 | Source: IBM’s SEC Filings
Let’s now circle back to the main agenda of this note: IBM’s Q3 2023 financial results. While our analysis of the financial results has thrown up a lot of observations, we believe three are worthy of nearly all the focus and attention. Read on for the finer details.
1/ First, IBM’s growth in the past two quarters has been primarily driven by software. When calculated YoY, this translates to 7.2% in Q2 2023 and 7.8% in Q3 2023. This contrasts drastically with its infrastructure business, which has been shrinking rapidly since the beginning of FY23. In addition, while within the software business, both portfolios are witnessing almost equally strong traction, in the consulting business, Application Operations has been growing most robustly. See image 7 below for more details.
Image 7: IBM Segment Growth | Source: IBM’s 2023 SEC Filings
We at Greyhound Research believe IBM’s growth spurt in its software business does not come as a surprise and talks volumes about what the company will look like in the coming times. Of course, much credit for this change must be given to the direction the company has taken after its acquisition of RedHat and course corrections to focus on the opportunity of Hybrid Cloud that feeds all its business units. In addition, the company has also made significant efforts by committing considerable resources to modernize much of its software stack for public cloud consumption and to be offered via marketplaces across hyperscalers.
2/ More to the point above, the growth of IBM Consulting is playing a key role in propelling IBM Software. It’s worth noting that while at the end of FY22, IBM Software contributed 41.4% to the company’s revenue, the current percentage (without accounting for the results for Q4 2023) is already at 42.3%. A similar increase can also be seen for IBM Consulting, whose contribution has increased to 33.6% (FY23 YTD) from 31.6% in FY 2022. See image 5 above for more details.
Interestingly, on double clicking, it is noticed that much of this growth in IBM Consulting is due to Application Operations, including application and cloud platform services required to operationalize and run cloud platforms. In other words, services to run a typical enterprise-grade hybrid cloud environment that includes key workloads like Oracle and SAP run on AWS, Azure, GCP and others. This includes using and selling IBM Software like Cloud Paks, RedHat OpenShift, and other IBM software stacks around Security, Automation & AI that are sold via partner marketplaces as SaaS and in the traditional licensing manner. Hence, much of the growth in IBM Consulting helps feed growth for IBM Software and vice versa. Also, in case you missed it earlier, it is worth noting that IBM Consulting houses the largest Red Hat practice across all key consulting firms.
We at Greyhound Research believe, for a company that has traditionally excelled in IT services and consulting and hence used to large ticket contracts, the efforts to make its software available on a pay-as-you-go basis via partner marketplaces is quite the leap. Of course, migrating existing contracts and navigating the complexities of Bring-Your-Own-License to the cloud will take time and effort. Still, this change is important in the company’s history.
3/ Another aspect of Q3 2023 that stood out was the focus on WatsonX, IBM’s Enterprise AI platform with three components: watsonx.ai, watsonx.data and watsonx.governance. Aimed at helping enterprises across the entire data and AI lifecycle, the platform and its components offer a wide range of capabilities, including (but not limited to) machine learning, data management and, most importantly, generative AI capabilities to train, validate, tune and deploy AI systems. With its ability to run this on a hybrid cloud architecture via RedHat assets, IBM believes these capabilities position it well for enterprises looking to explore and use AI for their businesses.
Alongside WatsonX, IBM has displayed its stack and expertise in Generative AI in recent months. The image 8 below does great justice to it. Have a look.
Image 8: IBM Generative AI Technology Stack & Expertise | Source: IBM’s 3Q 2023 Quarterly Earnings Presentation
Interestingly, when writing this research note, IBM announced a $500 million venture fund to invest in AI startups focused on generative AI for the enterprise. We at Greyhound Research believe, if executed well, this $500 Million Enterprise AI Venture Fund can help put IBM way ahead of its peers like Microsoft, Google and OpenAI. In theory, IBM has what it takes to become the most formidable player in the space – deep industry-specific and consulting capabilities, in-house AI experts with deep research experience, solid client relationships and a brand-new outlook to working alongside the ecosystem to foster growth.
We at Greyhound Research believe IBM is undoubtedly well-positioned to lead the Enterprise AI space. Having said that, the world of enterprise sales is well known to throw many-a-curveballs and time will unfold many surprises for IBM along the way. The one surprise that we can already anticipate is the efforts that IBM will have to make to change the perception of the brand Watson that garnished much negative press and customer feedback in the past. Another struggle that IBM (and all others in the Generative AI space) will face is the need to prove that the proposed technology is revolutionary and distinct from what is already available. Otherwise, it won’t be too long before stakeholders start posing doubts about the effectiveness and newness of the technology and touting it as old wine in a new bottle. Those who have greyed their hair in the world of technology will relate.
In summary, we at Greyhound Research believe that, although the New IBM carries forward select legacy and work from the past, the company now has a new outlook and is geared towards the opportunity of Hybrid Cloud and AI. The latest announcements of WatsonX, the Generative AI platform, and many others highlight the company’s efforts to catapult and be future-ready. However, the truth also is, as is the nature of strategic changes of this quantum, a lot of this work is still in progress and far from perfect.
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