IBM Earnings Preview: Services Revenues To Grow In Q3 On Better Order Backlog

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International Business Machines ( IBM ) is set to announce its Q3 earnings on October 16. In Q2, IBM reported a 3% y-o-y decline in revenues to $24.9 billion, negatively impacted by cross currency headwinds. Its global technology services ( GTS ) and global business services (GBS) divisions reported mid-single digit declines in revenues. However, the software business saw growth in Q2 and posted mid-single digit gains primarily on 9% y-o-y growth in middleware revenues.

In its 2015 roadmap, the company stressed that it was focused on emerging growth economies, big data analytics and cloud computing services. While IBM reported a lackluster performance from growth economies in Q2, its new initiatives in business analytics, smarter planet and cloud delivered strong growth. We expect IBM will continue to report revenue growth in these new business initiatives. Moreover, we expect that software revenues will continue to grow during the quarter on strong demand for key branded middleware and adoption of IBM's software cloud services. Additionally, we expect GTS and GBS to report growth in revenues due to an improvement in order backlog.

See our full analysis on IBM

Middleware To Report Growth

The middleware division and the operating systems division are the biggest contributors to IBM's stock value, together making up nearly 55% of our estimate. During Q2, the software division (middleware and operating systems combined) reported 4% y-o-y growth in revenues to $6.4 billion. This growth primarily came on 9% y-o-y growth in key branded middleware revenues. The company reported growth in all sub-brands of its software business. We expect this trend to continue in Q3 as well. The Middleware and Operating System divisions are important for our valuation of IBM as they have the highest EBITDA margins of almost 47%. We expect IBM will continue to report high margins for these divisions during the quarter.

Backlog To Bolster Services Revenues

The Global Technology Services ( GTS ) and Global Business Services (GBS) divisions contribute over 35% to IBM's stock value according to our estimates. While both these divisions reported revenue declines in Q2, we expect their revenues to grow this quarter mainly due to an improvement in order backlog.

IBM reported backlog growth for both its transactional and outsourcing businesses in Q2. The total backlog grew by 3% to $141 billion which indicated that IBM's clients signed new contracts or renewed old contracts with the company. We expect GTS and GBS to report higher revenues from backlog in this earnings announcemnt. Additionally, we expect the backlog to continue to improve in Q3, which should add more stability and growth to its services revenues in the coming quarters. Moreover, IBM's foray in high growth and high value businesses such as business analytics, Smarter Planet and cloud computing will help bolster GBS' revenues for the quarter.

Server Division Revenues To Remain Tepid

According to IDC, the worldwide server market revenues declined by 6% in Q2 2013 due to lower demand. Additionally, IBM's market share in servers declined from 29.1% in Q2CY12 to 27.9% in Q2CY13. We expect the decline to continue in Q3 as well and IBM to report lower revenues for the server division.

However, its high end System-Z server witnessed double digit growth in revenues in Q2, and we expect this to continue in Q3. System-Z demand is on the rise as IBM's clients continue to demand mainframes with high processing power and big data analytics capability. Therefore, we expect that the high demand for System-Z will offset soft demand for its System-X and Power system servers. We are closely watching IBM's revenue from System-Z servers as it is an important driver for our revenue forecast of the server division.

We currently have a $234 Trefis price estimate for IBM which is about 25% higher than the current market price.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: ACN , DELL , GTS , HPQ , IBM

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