IBM's Q3 Was A 'Tale Of 2 Cities'

Beats, But Quality Not High

Analyst Jim Suva noted that IBM reported third-quarter sales and earnings per share ahead of estimates. The analysis of the beats did not reveal high quality, the analyst said. According to the analyst, the top line was masterminded by a lower tax rate (14 percent versus estimated 18–19 percent), boosting earnings per share by $0.15.

Guidance Reiteration: A Positive

Citi also noted that the company reiterated its full-year earnings per share guidance of $13.50 and free cash flow at the high-end of the $11 billion to $12 billion target. This, according to Citi, is a positive, as most Buy-side analysts had expected a downgrade of earnings per share forecast.

Related Link: IBM's Margins Were The Big Problem

Strategic Imperatives Growing

Segment-Wise Revenue Performance

• Trailing 12-month revenues from Cloud at $12.7 billion, up from $11.6 billion in the second quarter.
• Software revenues up 3 percent, although contributions from acquisitions were not disclosed. The company did say acquisitions added about 2 percent year-over-year in constant currency.
• Generated $528 million of intellectual property income, up from $188 million last year. Citi now models $300 million per quarter, going forward.

Sore Points

Citi noted that gross margins declined 210 basis points, and operating margins fell 160 basis points, dragged by investment in strategic growth initiatives. The firm believes the margin contraction may end in 2017. Additionally, the firm does not believe the lower tax rate advantage will persist and accordingly, estimates a normalized tax rate of 20 percent in the years ahead.

Citi also highlighted on a decline in signings, which came in below its estimate. Reflecting peaking of IBM's mainframe cycle, the firm noted that hardware revenues fell 25 percent year-over-year. Global business services revenues declined 1.6 percent in constant currency, the firm noted.

Revising Estimates, Reiterating Rating, Price Target

Consequently, Citi trimmed its revenues and earnings per share estimates, reflecting lower reported revenues and outlook.

As such, the firm reiterated its Neutral rating and $160 price target.

In pre-market trading, shares of IBM were down 2.55 percent at $150.82.

Full ratings data available on Benzinga Pro.