The HashiCorp acquisition, GenAI and Red Hat taking on VMware are likely to come up.

Updates on the HashiCorp acquisition. Details on IBM’s approach to the artificial intelligence gold rush. And IBM subsidiary Red Hat taking on VMware and legacy virtualization vendors.

These are just some of the topics analysts will likely bring up Wednesday during Armonk, N.Y.-based IBM’s second fiscal quarter earnings, which cover the three months ended June 30.

Morgan Stanley in a July 18 report called itself “tactically cautious” going into IBM earnings, citing potential weakness in the IBM Consulting business unit as part of the reason.

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IBM Earnings Preview

“IBM deserves credit for narrowing its focus, driving more consistent performance, and shifting its portfolio to more recurring (software) and Services, however revenue growth has slowed since 2022,” according to Morgan Stanley.

In a Bernstein report on July 16, the investment firm predicted $15.7 billion in revenue for the quarter, in line with IBM’s past performance but above the consensus Wall Street figure of $15.6 billion (a July 18 Morgan Stanley report went with the consensus figure).

A July 15 Bank of America report said that the firm expects IBM to maintain its financial expectations for the year, which includes about $12 billion in free cash flow for the year. The firm predicted second-quarter free cash flow of $1.7 billion.

This is also IBM’s first earnings report since its IBM Think conference in May, perhaps giving solution providers a chance for executives to follow up on the various product news from the conference.

Read on for more of what to expect during IBM’s second quarter earnings call.

HashiCorp And Recent Acquisitions

Analysts will likely want updates on IBM’s pending acquisition of HashiCorp and recent purchases of StreamSets and webMethods from Software AG and Apptio.

Analysts will not only want to hear more about executives’ plans for HashiCorp once acquired, but an update on the buying process following HashiCorp’s disclosure that on July 12, HashiCorp and IBM each received a second request for information from the Federal Trade Commission as part of the FTC’s review of the merger, according to a regulatory filing by HashiCorp.

HashiCorp said in the filing that the deal is still expected to close by the end of 2024. But a Bernstein report on July 16 said that second requests for details are “often a precursor to regulatory challenges.”

“Investor consensus still appears sanguine, pricing the deal at >90% odds of closing on time,” according to Bernstein. On July 15, HashiCorp shareholders approved the acquisition by IBM, according to HashiCorp.

The Bernstein report said that the firm expects acquisitions to add about 100 basis points to IBM’s 2024 revenue growth. The firm put contributions from StreamSets and webMethods at about $300 million over two quarters, from purchased Apptio at $380 million over two and a half quarters and from the pending HashiCorp deal at $75 million over half a quarter.

In the quarter, Apptio likely contributed about $120 million, 270 basis points of growth, to IBM’s hybrid platform business, according to Bernstein.

IBM’s $500 million sale of QRadar assets to Palo Alto Networks should bring in more free cash flow in the third quarter, according to Bernstein. The firm put the addition to IBM between $300 million and $400 million after closing costs and taxes.

A July 18 report from Morgan Stanley said that the QRadar deal “could have a small, potentially positive, impact to CY24 Software growth (given Security has been a declining business).”

The Morgan Stanley report said the Apptio, webMethods, StreamSets and HashiCorp acquisitions—along with the current mainframe and Enterprise License Agreement (ELA) cycle —meant “potential for growth to reaccelerate in 2025.”

But for IBM to alleviate concerns around the second half of 2024, the vendor “has to execute flawlessly,” according to Morgan Stanley.

In a July 15 report by Bank of America, the firm said that it expects Apptio and the Software AG assets to drive about 2 percent year-over-year revenue growth in 2024.

IBM Software

During the earnings call, Bernstein analysts will look for “commentary that could provide conviction into the sustainability of TPP growth or the growth rates for hybrid platform ex. Red Hat more broadly” because Red Hat and transaction processing are large parts of IBM’s software business, according to the report.

TPP is mainly made “of the company’s mainframe software offerings and accounted for 12% of total revenues and an estimated 29% of total profits in 2022.”

Price increases have helped the transaction processing business go from about 5 percent decline in compound annual growth rate (CAGR) from 2018 to 2023 to 3 percent growth in the first quarter of 2024, according to Bernstein. IBM has said the business unit should grow 2 percent for all of 2024.

Bernstein models 3.4 percent growth in the second quarter ignoring foreign exchange, but the firm lacks “conviction in the durability of TPP’s pricing power, and see a longer term risk that more aggressive pricing could accelerate migration off the mainframe platform.”

“We expect the next mainframe in Q1 2025,” according to the firm.

For IBM Software overall, Bank of America models revenue to grow 5 percent year over year, in line with IBM’s forecast.

In IBM Software overall, Morgan Stanley said “we believe the recent momentum” in the business unit “will likely continue into 2Q and are raising our 2Q Software revenue growth forecast by” 150 basis points to 7.4 percent growth year over year ignoring foreign exchange.

Surveys by Morgan Stanley showed a mixed picture for IBM, with resellers describing an acceleration in their Red Hat practice and 2024 but CIOs describing a deceleration not only in Red Hat but also IBM CloudPaks and Cloud.

Morgan Stanley’s latest quarterly CIO survey, published July 11, named IBM with Oracle, Dell and VMware as having the highest risk of losing budget share over the next three years due to customers moving to the cloud. Microsoft and Amazon were best positioned to gain IT budget share in that period.

Red Hat Vs. VMware

On Wednesday’s call, analysts will likely look for details on growth for IBM subsidiary Red Hat and whether the vendor is capitalizing on the need for open-source software in AI.

The Bernstein report said that “Broadcom’s acquisition of VMWare (a major competitor) could benefit Red Hat in terms of both market share and pricing,” noting that Red Hat posted a third consecutive quarter of midteen booking growth in IBM’s prior quarterly earnings.

“While we struggle to see revenue getting back to the low-mid teens underlying growth seen in 2022 and before, we believe ~10-11% growth is likely achievable in 2024-25, and we expect 10 – 11% revenue growth at CC for Q2, up from 9% in Q1 and 7% in Q4,” according to Bernstein.

In the Bank of America report July 15, the firm said that it models stronger revenues for Red Hat, with “double-digit y/y growth in F3Q and F4Q” due in part to “strong bookings over the past quarters” and “any share gains from disruption caused by the” Broadcom acquisition of VMware.

In a July 18 Morgan Stanley report, the firm predicted “steady” Red Hat growth of 9 percent year over year ignoring foreign exchange.

On July 16, Red Hat released the latest version of Red Hat OpenShift. Version 4.16 adds a Virtualization Migration Assessment to take organizations through a risk assessment methodology to help determine the best path for migration away from a legacy virtualization solution—apparently capitalizing on disruption from Citrix’s recent merger and VMware’s merger.

The new version also adds a technology preview for OpenShift-based Appliance Builder, meant for building turnkey, customized appliances with self-contained Red Hat OpenShift instances.

Red Hat also made Advanced Cluster Security Cloud Service generally available, giving users a fully managed Kubernetes-native security cloud service that supports Red Hat OpenShift as well as Amazon Elastic Kubernetes Service (EKS), Google Kubernetes Engine (GKE), Microsoft Azure Kubernetes Service (AKS) and other non-Red Hat Kubernetes platforms.

IBM Consulting

While the 2 percent growth ignoring foreign exchange for IBM Consulting, No. 6 on CRN’s 2024 Solution Provider 500, disappointed Bernstein last quarter, the firm sees “some potential improvement in” demand, according to the firm’s report.

Consulting rival Accenture “had strong bookings,” up 22 percent year over year with $900 million in AI bookings, while HCLTech saw “stronger backlog realization.” Bernstein expects IBM to “increasingly benefit from nearly $1B in AI consulting signings.”

Consulting firms overall have said “that demand remains relatively weak,” according to the Bernstein report. “We note that while IBM has continued to grow above peers, its growth premium has narrowed, and the business could be sensitive to industry level dynamics.”

Bernstein analysts will watch for “key leading indicators like book:bill and signings as well as commentary on the consulting strategic partnerships and AI book of business,” according to the report.

Traction in IBM’s AI consulting business “could be a potential leading indicator for enterprise AI more broadly,” according to Bernstein.

“IBM has stated that its AI consulting book of business is approaching $1B (vs. a total backlog of ~$30B) if half is ultimately realized this year, it could be a ~200 bps boost to consulting revenues this year, all else equal,” according to the report. “CIOs were more likely to agree than disagree that they would use consultants to help deploy AI/LLMs.”

In a July 18 Morgan Stanley report, the firm said that IBM could cut guidance to the consulting business for the second time in a row.

Active IBM Consulting daily job postings have fallen 34 percent from the end of the first quarter and the 90-day rolling average fell 29 percent from the February 2024 peak, a negative sign for the business, according to the firm.

Morgan Stanley predicts 2.3 percent year-over-year growth ignoring foreign exchange for the business unit and 2.5 percent for the full year, both below Wall Street consensus.

“Our checks have pointed to a continued challenging Consulting spending environment, and we see discretionary spending still at-risk (Services is still a budget share donor to help fund Gen AI projects), while Generative AI consulting projects don’t appear to be having any material incremental impact on Consulting growth today,” according to Morgan Stanley.

Morgan Stanley’s latest quarterly CIOs survey showed that IBM was less willing to discount on consulting prices compared with rivals, especially ones with large presence in India including Tata Consultancy Services, HCLTech, Wipro and Cognizant Technology Solutions.

“IBM’s net negative discounting score in our 2Q24 survey implies IBM continues to command a premium for its consultative services,” according to Morgan Stanley.

Still, based on Morgan Stanley survey data, “a net 12% of IT Services Domain experts expect to spend more with IBM over the next 12 months, down from 20% in our 4Q23 CIO survey (the only Services company to see this metric deteriorate vs. 4Q23), and below the IT Services average for the first time in 4 quarters.”

The firm also found IBM “to be the biggest net share donor from IT Services vendor consolidation … and when asked which vendors provide the highest quality level of strategic consulting, only 8% of CIOs cited IBM, down 6 points vs. 4Q23, and below the IT services average for the first time since 2Q21,” according to the report. “Overall, we view these data points as more cautious leaning, especially after IBM screened so positively just 2 quarters ago.”

Although Accenture’s recent performance showed “encouraging” signs for the consulting sector, Bank of America noted in its report that “we believe IBM continued to see some pressure from smaller, more discretionary projects in F2Q.”

The firm put IBM Consulting revenue at mid-single digits year over year ignoring foreign exchange, which IBM also forecasted.

IBM AI

Amid the AI gold rush, Bernstein noted that “IBM has launched a range of AI related offerings, but the market continues to assign limited value to IBM’s ability to participate in AI.”

“It is unclear that IBM will ultimately be an AI winner,” according to the Bernstein report, although “most enterprises are still in the experimentation phase.”

The firm estimated that IBM saw between $150 million and $200 million in AI revenue in the third quarter of 2023 and between $300 million and $400 million in the fourth quarter, mostly in consulting.

IBM’s leadership has also pointed to a “potential to win with open-source, smaller models in generative AI, and its shift to a more technical sales model as supporting these ambitions,” according to Bernstein.

Bernstein estimated that IBM saw more than $450 million in the first quarter of 2024, up 12 percent, “somewhat disappointing” and “a relatively low hurdle.” The majority of AI bookings was likely in IBM Consulting.

“We encourage investors to monitor updates to IBM’s AI ‘book of business’ and hope to get further clarity,” according to Bernstein. “That said, nearly $1B in AI consulting bookings to date could potentially lead to $300 – $500M in AI consulting revenues this year (versus very little last year).”

Bernstein said in its report that it will look for IBM executives to talk about “progress and data points on AI” as well as “the overall health of corporate IT spend and any impacts from AI ‘freeze outs.’”

The firm has data to suggest some CIOs have experienced “AI paralysis, in which spend is being scrutinized more closely in case it can ultimately be replaced by AI.”

IBM’s business process outsourcing unit is vulnerable to AI, with potential price reductions of up to 50 percent, according to Bernstein. However, BPO is only about 5 percent of IBM’s revenue, which “creates an opportunity for it to go on the offense as the market is potentially disrupted.”

Morgan Stanley’s latest quarterly CIO survey, published July 11, named IBM with Hewlett Packard Enterprise, VMware, Oracle and Dell as losing spend on generative AI in 2024 and over the next three years.

Microsoft was widely expected to gain the largest incremental share of GenAI spending in 2024 and over the next three years, according to Morgan Stanley.