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Earnings Outlook: IBM earnings: Chief executive’s first big move will be more scrutinized than the numbers


Arvind Krishna took over as IBM chief executive earlier this year.


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International Business Machines Corp.’s overshadowed its own earnings report with plans to spin off its datacenter outsourcing business.

IBM
IBM,
+0.83%

is scheduled to report third-quarter earnings after the bell on Monday, after surprising the tech world Oct. 8 by announcing it would execute a tax-free spinoff of its managed infrastructure services unit, or its IT outsourcing business, sending shares up 6% on the day. The spinoff, which IBM dubs “Newco” for now, is currently part of the company’s Global Technology Services division and accounts for an estimated $19 billion in annual revenue, compared with the remaining company’s $59 billion in revenue.

IBM said Newco, which will focus on modernizing the IT infrastructures of clients and managing multi-cloud environments, will be twice as large as its nearest competitor, which IBM did not name. Analysts listed competitors in the space as DXC Technology Co.
DXC,
+2.03%
,
Microsoft Corp.
MSFT,
,
Oracle Corp.
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-0.38%

and Rackspace Technology Inc.
RXT,
-1.55%

What’s left behind is IBM’s hardware, software and services business that IBM Chief Executive Arvind Krishna said would be “laser-focused” on what the company sees as a $1 trillion hybrid-cloud market. IBM has been making grand claims about its commitment to be the leader in hybrid cloud since it announced its $34 billion acquisition of Red Hat two years ago. In a hybrid-cloud arrangement, a company keeps some of its data in a public cloud service and some of its data on servers on its own premises, often for regulatory reasons, such as in the cases of financial institutions or health-care facilities.

Evercore ISI analyst Amit Daryanani, who has an in-line rating and a $137 target price, said the spinoff would create a “structurally better asset” that gibes executives and investors a true focus.

“We think this is a positive step for IBM to further simplify their narrative and drive a more consistent growth narrative,” Daryanani said.

IBM provided estimates for its third-quarter results along with the announcement, so investors already know what numbers are coming. They are likely to care more about details on how the company plans to execute the spinoff, so check the earnings call for the new chief executive’s discussion of his first big move at the helm of Big Blue.

What to expect

Earnings: IBM provided preliminary earnings of $2.58 a share when it announced the spinoff earlier in the month. Of the 12 analysts surveyed by FactSet, IBM on average is expected to post adjusted earnings of $2.57 a share, up from the $2.55 a share expected at the beginning of the quarter, but down from the $2.68 a share reported in the year-ago third quarter. Estimize, a software platform that uses crowdsourcing from hedge-fund executives, brokerages, buy-side analysts and others, calls for earnings of $2.62 a share.

Revenue: IBM forecast preliminary revenue of $17.6 billion. Wall Street expects revenue of $17.62 billion from IBM, according to 10 analysts polled by FactSet. That’s up from the $17.15 billion forecast at the beginning of the quarter, but down from the $18.03 billion reported in the year-ago quarter. Estimize expects revenue of $17.75 billion.

Stock movement: Over the third quarter, IBM shares rose 0.8%, compared with a 7.6% rise on the Dow Jones Industrial Average
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an 8.5% on the S&P 500 index
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and a 11% on the Nasdaq Composite Index
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.

What analysts are saying

Bernstein analyst Toni Sacconaghi, who has a market-perform rating and a $125 price target, expressed a bit of skepticism about the spinoff, questioning whether it was “value creation or shuffling deck chairs.”

“IBM may not have a major update or an analyst day until at least midyear, and in the meanwhile, Q3 results are known, reported Q4 EPS will be very weak (~$2 vs. consensus of >$4) due to its restructuring charge, and execution issues around the spin are non-trivial,” Sacconaghi said.

Citi Research analyst Jim Suva, who has a neutral rating and a $140 price target, said even though the spinoff was a positive change for IBM, enterprise spending was still sketchy in the meantime.

“We believe there remains a lot of volatility with mixed nature of demand with several enterprise clients likely looking at breaking up their projects into smaller pieces and smaller contracts that have rapid results and less risk around completion dates/timelines and deliverables,” Suva said.

MoffettNathanson analyst Lisa Ellis, who has a sell rating and a $125 price target on IBM, said the move was one she and other investors had “been hoping for” but said it would take a while for the benefits to kick in.

“While strategically compelling, the spin does not create immediate financial benefits: like most divorces, it is expensive and arduous,” Ellis said. “It’s not expected to be completed until late 2021, and IBM will be taking a total of $4.8 B in charges in 2020 and 2021 for restructuring and transaction related costs, without significant near-term gains – IBM is reinvesting the cost savings from the restructuring.”

Of the 15 analysts who cover IBM, four have buy or overweight ratings, nine have hold ratings and two have sell or underweight ratings, with an average price target of $137.08.



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