IBM Revenue Lags as Cloud Pivot Remains a Challenge

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IBM -0.32%

International Business Machines
Corp.

said revenue fell for its fourth straight quarter as it struggles to retool its business for the modern computing age, although Big Blue’s profit grew more than Wall Street had projected.

Revenue fell 4.2% from a year earlier to $19.16 billion. Profit rose 3.9% to $2.5 billion, as the company worked to scale back its exposure to businesses with smaller profit margins.

IBM has trailed

Microsoft
Corp.

and

Amazon.com
Inc.

as customers race to do more of their computing in the cloud—online services that free companies from the need to buy and maintain their own systems. As competitors report consistently strong revenue growth, buoyed by sales of their cloud services, IBM has absorbed a string of declines.

While IBM, led by Chief Executive Ginni Rometty, says its cloud business is growing—cloud revenue climbed by 5% in the second quarter—it is far behind the 41% annual cloud revenue growth Microsoft saw in its latest quarter.

Meanwhile, other parts of IBM’s business are in a gradual decline. Revenue in the company’s IT services division fell by 6.7% year-over-year in the second quarter as the company lost sales from lower-margin equipment it is transitioning away from.

The division that houses IBM’s mainframe business also fell almost 20%, although it faced a tough comparison to last year, when the release of a new generation of those computers buoyed sales.

Ms. Rometty is now betting on IBM’s $34 billion acquisition of open-source software giant Red Hat Inc. to seed a revenue rebound after earlier cloud deals like the $2 billion acquisition of Dallas-based SoftLayer failed to vault the company over the competition. The Red Hat deal, the biggest in IBM’s history, closed earlier this month.

“That Red Hat acquisition will change the dynamics of our growth profile, and it will change the dynamics of our cloud growth profile overall,” Chief Financial Officer James Kavanaugh said in an interview. The deal would boost revenue by two percentage points annually over the next five years, he said.

IBM expects to update financial projections in connection with the Red Hat deal Aug. 2; the acquired company’s performance wasn’t factored into IBM’s second-quarter numbers.

While second-quarter revenue was in line with analysts’ expectations, earnings on an adjusted basis of $3.17 a share beat expectations from analysts polled by FactSet.

Mr. Kavanaugh said IBM made $575 million from long-planned asset sales in the quarter. But costs including a legal ruling against IBM and payouts associated with a round of layoffs mostly outside the U.S. at the end of June ate up most of those gains, he said.

Shares moved down about 1% after hours to $143. The stock initially showed gains following the earnings release.

IBM executives point to bright spots in the growth of cloud services and tout the future of its artificial intelligence business. The company wants to be at the center of companies increasingly using AI to run their operations.

Tuesday, IBM said it landed a multibillion deal with

AT&T
Inc.

where it would help the telecommunications giant shift business-service applications to IBM’s cloud.

But Red Hat had already been an AT&T partner, and it wasn’t clear whether IBM’s acquisition played any role in inking that deal, said Toni Sacconaghi, an analyst at Bernstein Research.

“The belief is that owning Red Hat and going to market more aggressively with it” will help IBM land more deals to provide services to companies or help them move to the hybrid cloud, he said. “That is the theory of the deal. The proof will be in the execution.”

Ms. Rometty took the helm in early 2012, at a time when IBM was under pressure to meet a tough earnings-per-share target set by her predecessor, Sam Palmisano. The company bought back billions of dollars worth of shares and sold off underperforming assets in its bid to meet that goal, but Ms. Rometty ultimately scrapped the program in 2014 as it became clearer that the company needed to invest in a more radical transition to stay competitive.

IBM had raked in cash from long-term deals with big companies to supply them with hulking mainframe computers, plus IT support and consulting to go along with them. The transition to cloud computing meant companies needed less hardware, and could pay for only the computing power they needed.

IBM’s revenue started declining from almost the start of Ms. Rometty’s tenure at the helm, and fell year-over-year for 22 straight quarters. The company appeared to have turned a corner when it posted growing revenue for three quarters starting in late 2017, but that rise was due largely to sales of a new generation of mainframes, and it proved temporary. The revenue declines started again in 2018, and have persisted since.

The company is now trying to revive revenues and distinguish itself from the competition by focusing on the so-called hybrid cloud, a model where companies do some of their computing in the cloud but keep their most sensitive data in-house.

The hope is that the acquisition of Red Hat, which sells support for a version of the open-source Linux operating system, will boost IBM in the hybrid cloud arena because Red Hat software is at the core of many customers’ IT infrastructure.

Write to Asa Fitch at asa.fitch@wsj.com

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2019-07-17 23:09:00

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