Shares of IBM Corp. (NYSE: IBM) rose in after-hours trading Wednesday following news that the technology giant posted better than expected quarterly earnings. But the rally quickly fizzled as investors struggled to make sense of the company’s strategic transformation following the $34 billion acquisition of Red Hat.

 

Q2 2019 Earnings Summary

  • Earnings: $3.17 per share
  • Revenue: $19.16 billion

Excluding certain items, IBM’s per-share earnings were $3.17 in the second quarter, easily topping forecasts calling for $3.07. Revenues came in at $19.16 billion, in line with the consensus.

IBM’s revenues were down 4% compared with year-ago levels, marking the fourth consecutive quarter of year-over-year declines. Global technology services — the company’s largest component — saw revenues fall 7% year-over-year. Sales in this category are expected to decline for the rest of the year as the company pivots away from capital-intensive business, according to CNBC.

IBM’s stock rose as much as 4% in after-hours trading before reversing course a few hours later. The stock closed down 0.3% in regular hours but is still up 26% year-to-date. That’s well ahead of the S&P 500 and Dow Jones Industrial Average.

At current values, IBM has a total market capitalization of $126.8 billion.

IBM Share Price YTD - Jul 17 2019

Source: Yahoo Finance

Turning Point?

The acquisition of Red Hat last November was supposed to catapult IBM’s cloud ambitions forward, but the deal is unlikely to contribute to the bottom line anytime soon.

The big question heading into Wednesday’s earnings call was whether IBM was turning the corner fast enough to offset declines in its legacy business. The raw numbers suggest the transition is well underway.

Case in point: IBM’s cloud and cognitive software unit generated $5.65 billion in revenue, which was well ahead of forecasts calling for $5.55 billion. IBM’s cloud business saw annual growth of 27.6% in Q4 2018. While impressive, it lagged well behind cloud industry leaders Amazon Web Services, Microsoft Azure, Google, and Alibaba.

IBM still has a lot of work to do to catch up to its competitors. By the end of 2018, its share of the worldwide cloud infrastructure market was 3.6%, according to Canalys. By comparison, AWS had secured 32.3% of the market and Microsoft Azure 16.5%.

The acquisition of Red Hat last November was supposed to catapult IBM’s cloud ambitions forward, but the deal is unlikely to contribute to the bottom line anytime soon. IBM officially closed the Red Hat acquisition last week and informed investors Wednesday that more information on its impact will be provided Aug. 2.

 

Conclusion

IBM has a lot at stake in Red Hat. After all, it sold $20 billion in bonds just to fund the acquisition. Investors will be keenly awaiting further details in early August.

Looking ahead, IBM’s generous dividend yield, which is more than quadruple the technology sector average, could be at risk if margins don’t improve anytime soon.

Disclaimer: Author holds no investment position in IBM at the time of writing.