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IBM (IBM) Q3 Earnings on Deck as Earnings Season Gets Underway

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IBM (IBM - Free Report) is set to report their third quarter results after the closing bell on Tuesday, October 15th as Q3’s earnings season gets underway this week. IBM shares have risen over 24% this year lagging behind the broader computer office equipment market’s 34.5% gain.

The company is coming off a second quarter where they reported mixed results and decided to not provide any financial guidance for the third quarter or the full fiscal year until later in the year. IBM finalized its $34 billion buyout of open-source software company Red Hat on July 9 and will affect its year over year figures in this upcoming report.

Red Hat Acquisition

When the buyout of Red Hat was announced in October 2018, it marked the biggest acquisition in IBM’s history and one of the largest tech acquisitions of all time. The acquisition is IBM’s latest initiative to establish itself in the cloud computing space, as cloud computing has become a focal point for many tech giants like Amazon (AMZN - Free Report) , Google (GOOGL - Free Report) , Microsoft (MSFT - Free Report) , and others.

IBM is going all in on cloud computing with this acquisition as they try to prove themselves capable of carrying their storied legacy into the modern era. Red Hat generated $3.4 billion in fiscal 2019, and has been growing its revenue at a double-digit pace. Over the next five years, IBM expects the acquisition to boost its revenue growth rate by about 2% annually.

Red Hat’s buyout required IBM to take on a large amount of debt. The company said it is focused on repaying the debt it took on from the acquisition and plans to refrain from share buybacks in 2020 and 2021. However, IBM is committed to increasing its dividend despite its debt, which should keep shareholders satisfied for the time being. IBM's annual cloud revenue has grown to $19 billion, representing about 25% of total revenue.

Company Outlook

Our Q3 consensus estimates forecast IBM to see a 22.81% drop in earnings to $2.64 per share and for sales to slip 2.73% to $18.24 billion. Cloud and Cognitive Software is expected to grow 30.3% to $5.4 billion and for Global Business Services to pop 0.31% to $4.14 billion. The Global Technology Services and Systems segments are anticipated to make respective drops of 18.1% and 14%. Global Financing is projected to come up short of the year ago quarter’s figure by 2.13%.

Looking ahead to fiscal 2019, consensus estimates forecast IBM to see a 7.31% drop in earnings to $12.80 per share and for sales to tumble 2.41% to $77.67 billion. Cloud and Cognitive Software is expected to lead the pack with a 31% jump to $23.4 billion while the Global Business and Global Tech Services segments make respective declines of 2.56% and 14.02%.

The Red Hat deal should provide some much-needed revenue growth for IBM and the company can accelerate Red Hat’s growth through cross-selling opportunities. IBM’s results should get a boost from the deal in the second half of 2019 and will reap the full benefits of the deal in 2020. IBM’s drive to accelerate its innovation efforts should also bode well for the tech giant as it filed over 9,000 patents in 2018.

The company’s commitment towards increasing its already hefty 4.54% dividend yield could entice investors to hold IBM shares while the company’s cloud initiative plays out. IBM sits at a Zacks Rank #3 (Hold) and has Style Score of A in Value.

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