IBM's third quarter a mixed bag as sales fall short, but earnings better than expected

IBM's bottom line performance was better than expected in the third quarter, but sales were mixed. Red Hat delivered revenue growth of 29% and the cloud and cognitive software unit saw sales grow 6%.

The company reported earnings of $1.87 a share on revenue of $18 billion, down 3.9% from a year ago. Currency fluctuations hit IBM's third quarter sales, which would have been down 0.6% adjusted for divested businesses and constant currency. Non--GAAP earnings for the third quarter were $2.68 a share. 

Wall Street was expecting IBM to report third quarter revenue of $18.22 billion, down nearly 3% from a year ago with non-GAAP earnings of $2.67 a share.

Going into IBM's report, analysts were looking for details on the Red Hat contribution to the third quarter as well as stabilization of Big Blue's core units--especially services. IBM closed the Red Hat purchase July 9 in what equates to a big hybrid- and multi-cloud play to spark growth. The third quarter is historically weak for IBM, but there is a new mainframe cycle too.

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Stifel analyst David Grossman said in a research note:

IBM is expected to ship a new mainframe and high end storage products in 4Q, which coincides with the anniversary of the headwinds from the previous mainframe cycle and will be optimized to run Red Hat Linux and OpenShift. Systems represents 10% of IBM's revenue and a 10 basis point headwind to IBM's revenue growth in 2019, which should convert to a 40 basis point tailwind in 2020.

For 2019, IBM projected non-GAAP earnings of at least $12.8 a share with free cash flow of about $12 billion.

CEO Ginni Rometty said revenue growth for cloud and cognitive software and global business services was a step in the right direction. The closing of the Red Hat deal hurt IBM's bottom line as expected.

By unit, the cloud and cognitive software unit, which includes Red Hat, had revenue of $5.3 billion, up 6.4%. Security, Internet of things, AI and cloud platforms drove revenue growth. This division got a boost from Red Hat.

The global business services unit, had revenue of $4.1 billion, up 1% from a year ago, and global technology services had revenue of $6.7 billion, down 5.6%. Systems revenue was $1.5 billion, down 14.7%, but the new z15 mainframe will boost results in future quarters. 

On a conference call with analysts CFO James Kavanaugh said Red Hat was bolstering IBM's wallet share and customer base. 

We've announced OpenShift on IBM Cloud and on IBM Z, and we've introduced consulting and technology services for Red Hat the capitalize on our expertise in digital reinventions and our leadership position in managing mission-critical workloads.

The 20% growth is an acceleration from Red Hat's performance before we announced the transaction. This quarter, Red Hat's infrastructure business, which is predominantly RHEL, had double-digit growth and continued to take share. This is a great proof point of the continued importance of Linux as a foundation for enterprise workloads in a hybrid cloud environment. And momentum continued in application development and emerging technologies, driven by both OpenShift and Ansible. We're adding new OpenShift clients and expanding Red Hat adoption in existing clients.