IBM (IBM) recently reported disappointing second-quarter financial results, driven by its customers’ prioritization of AI-related products the company doesn’t sell. Further, some of IBM’s biggest businesses are likely to be hurt by the continued proliferation of AI in the medium-to-long term.
Nonetheless, some of Big Blue’s largest businesses, including its lucrative Red Hat software offering, continue to perform very well; its profit, excluding certain items, still rose significantly in Q2 versus the same period a year earlier, and it has tremendous opportunities in a number of areas, including quantum, drones, and Physical AI. Also importantly, its CEO, Arvind Krishna, has done an excellent job during his tenure with the company so far, making me confident that he can effectively exploit these opportunities going forward. Finally, the stock’s valuation is quite attractive at this point.
IBM’s Disappointing Q2 Results and Future Challenges
Big Blue’s Q2 earnings per share, excluding certain items, and revenue came in at $2.93 and $17.2 billion, respectively, versus analysts’ average estimates of $3.02 and $17.86 billion. Krishna blamed the miss on high spending by IBM’s clients on AI-related infrastructure “ahead of expected price increases.”
Although the latter trend, which negatively impacted the demand for IBM’s mainframes and related software, is likely to ease over time as supply rises, the issue may continue to weigh on IBM’s results in the medium term. Similarly, worries over cybersecurity, also cited by Krishna as a negative factor for IBM in Q2, are likely to decline as new ways are found to combat hackers empowered by AI. However, the situation could negatively impact IBM for the next year or so.
Further, its consulting business may be undermined by AI while its AI offerings may be faced with increased competition.
Some of IBM’s Major Businesses Are Still Performing Well
Red Hat’s hybrid cloud offerings remain very popular and continue to grow rapidly, as the unit’s top line rose 11% in Q2 compared with the previous quarter, Krishna reported. Also performing well are the firm’s power and storage offerings within its Distributed Infrastructure unit. The latter division’s revenue jumped 37% versus the same period a year earlier, while it finished Q2 with a backlog of about $500 million. Moreover, Hashicorp and Confluent both of which were acquired by IBM in major deals and “provide critical building blocks for modern cloud software” used to facilitate AI, continue to produce commendable results, the CEO stated.
And in response to the launch of Anthropic’s extremely powerful AI model, Mythos, IBM unveiled a new cybersecurity tool that is already being used by many huge companies, including Bank of America (BAC), Goldman Sachs (GS), and Wells Fargo (WFC).
These strong performances enabled IBM’s earnings per share, excluding certain items, to climb 5% versus the same period a year earlier to $2.93. Additionally, the company’s free cash flow for the first six months of the year came in at a robust $4.76 billion.
Tremendous Potential and a Strong CEO
Investment bank Susquehanna expects IBM “to capture a disproportionate share of a $650 billion quantum-computing market by 2040.” If Big Blue can get a 20% share of the sector, the business would generate $130 billion of revenue for the firm in 2040, based on Susquehanna’s projection of quantum’s overall outlook. IBM’s total market capitalization is only around $200 billion now, so the firm’s efforts in quantum are likely to boost the shares tremendously.
Meanwhile, IBM, using its AI prowess, is providing drones with ” cognitive computing capabilities.” In partnership with a Dutch drone maker, Big Blue has unveiled “vehicles (that) can provide high-quality inspection services for global organizations across multiple industries.” Although IBM is currently focusing on enhancing commercial drones, it can and likely will in the future improve military drones as well. And it can bring “cognitive computing capabilities” to other Physical AI products.
Additionally, in February, the company announced that it had obtained a deal worth up to $151 billion “to support the Missile Defense Agency’s Scalable Homeland Innovative Enterprise Layered Defense” initiative.
Valuation on IBM
The tech giant’s forward price-earnings ratio of 17.4 times is rather low, given its positive catalysts and continued earnings growth.
Although the company has medium-term hurdles, its long-term outlook looks very favorable, making it a good name for investors with an extensive time horizon to consider.
*This article is intended to be informational only; it is not financial advice.
