IBM's software unit linchpin to reinvention

Big Blue's ability to hit the high end of its outlook largely depends on how its software unit performs. Can a cloud turn outpace software concerns elsewhere?

IBM's ability to retool itself and reinvent largely depends on the success of its software business---middleware, cloud and on-premise. At this point, however, it's a jump ball whether IBM can use its software business to turbo charge the overall company.

Big Blue's second quarter results were a mixed bag as expected. Non-GAAP earnings were better than expected, but revenue fell short. What was most notable about the IBM conference call is how the software business is the linchpin to the company's reinvention plan.

Previously: IBM reports mixed Q2 as strong dollar hurts revenue

Simply put, whether IBM hits the high end or low end of its annual revenue guidance largely depends on how its software business performs.

Here's the problem: IBM's software business is sucking wind. IBM's second quarter software revenue was $5.8 billion, down 3 percent in constant currency. Branded middleware was flat, but IBM is struggling in operating systems and plain vanilla middleware. Meanwhile, IBM is investing in Bluemix, a platform as a service cloud play, and Watson.

Martin Schroeter, CFO of IBM, pointed out how security, commerce and social software revenue was strong. Software as a service also did well. As for Watson, Schroeter said Watson is deployed in 30 questions and 20 industries.

But software as a service carries lower margins, IBM remains a mostly on-premise application company and investments in new areas will take time. In the meantime, IBM is seeing its software business at its slowest in years.

What IBM is looking for is its top clients to commit to the platform and have the flexibility to mix and match licenses. The game appears to be to keep customers in the fold and worry about profits later.

Like IBM's broader overhaul, the company's software unit has to win business in new areas to offset declines elsewhere.

Schroeter said:

On a gross profit level margin, the only real shift we see is a slight shift to our SaaS properties. So, while they come in at slightly lower margins than our traditional on-prem business, they are still highly accretive to the overall IBM model, because, bear in mind, these are new spaces for us. We're not taking and converting an on-prem business to an as-a-service business. We are building new revenue streams in spaces where we're not today. So, slightly lower gross margins on the SaaS business, but all accretive to the IBM model.