By Therese Poletti, MarketWatch
IBM Corp. achieved its first quarter of revenue growth in more than five years thanks mostly to the same technology that helped make Big Blue a tech titan in the past, which doesn’t exactly bode well for its future.
IBM sales increased year-over-year for the first time in 23 quarters in a decent earnings report Thursday that was overshadowed by news that it would take a $5.5 billion charge related to the U.S. tax overhaul. The charge pushed IBM’s fourth quarter into a net loss of $1.05 billion, or $1.14 a share. Before the charge, IBM’s adjusted earnings were $5.18 a share, compared with consensus expectations of $5.17, according to FactSet.
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The tax-related loss and a so-so forecast did not sit well with investors. IBM’s /zigman2/quotes/203856914/composite IBM +0.60% shares fell more than 3.5% to less than $163 in Friday morning trading. Before that decline, IBM was up 10% so far this year compared with the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -0.33% , which counts IBM as a component and is up 5%, as more optimism has been building among analysts for a turnaround and some revenue growth.
Much of that optimism surrounds IBM’s efforts in the cloud, artificial intelligence and other next-generation technology. But it was IBM’s Systems business — made up of its mainframe, server and storage businesses — that contributed the most to Thursday’s revenue gains, with sales surging 32% to $3.3 billion. In contrast, cognitive solutions — which includes artificial-intelligence services such as Watson Health and Watson Financial — grew revenue by only 3%.
This was the company’s first full quarter with its new z14 mainframe, and its new features such as pervasive encryption and the ability to address blockchain transactions led to new customers. Cyclical gains from businesses that are falling out of favor, even if they include buzzwords like blockchain, are not the best indicator of future success, though.
“Taking out the upswing from Z mainframe, IBM would not be showing growth, which remains the worry on the Street,” Daniel Ives, chief strategy officer and head of technology research at GBH Insights, wrote in an email. “The strategic imperatives segment remains the clear focus for the Street, as this is the core fuel in the company’s diesel engine.”
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IBM said that half of its systems revenue now addresses the workloads of its so-called strategic imperatives, which are its core future focus areas. Strategic imperatives as a whole, including cloud computing, cognitive computing and other services, were up 17%.
Company executives on the call with analysts said that IBM will continue to grow revenue this year, but that full-year 2018 earnings per share should be at least $13.80, flat or slightly higher than 2017 earnings. They did not give specific growth rates, but said that mainframes would continue to grow, albeit at a slightly slower pace.
Some analysts are also concerned that IBM is going to continue to find write-downs to lower its tax rate, ultimately paying a much lower rate than most other U.S. corporations. It said that while its underlying tax rate was 12% in the full year 2017, its operating tax rate was actually 7%, an incredibly low number that will be hard to replicate even with the recent tax cuts.
IBM seems to believes it can repeat that performance, however. The company said it probably will have some more tax benefits this year, which it calls “discretes,” so it doesn’t look like IBM is going to be paying the same tax rates as most other U.S. corporations anytime soon.
“Overall, it’s a small step in the right direction,” Ives said of the quarter. “The tax rate remains a hot-button issue and there is an opportunity to normalize it if IBM wants to go in that direction, although unlikely in my opinion.”
IBM promises to boost revenue for the full year, which is laudable after so many years of declines. But gains predicated on a cyclical gain for an old technology, and basically flat profits dependent on mind-blowingly low tax rates, are not results that should bring cheers from investors looking at the long term.