IBM Earnings Preview: AI Disruption and Software Growth Under the Microscope

IBM is set to release its fourth-quarter earnings report today after the market close, followed by a conference call at 5 PM ET. Investors will be closely monitoring IBM's results, not just for its financial performance but also for insights into the rapidly evolving artificial intelligence landscape, particularly following the emergence of DeepSeek as a potential disruptor in AI computing.

Earnings Expectations and Financial Overview

The FactSet consensus estimates IBM’s earnings per share for the quarter to come in at $3.78, reflecting a slight 2 percent year-over-year decline. Meanwhile, revenue is projected to grow modestly by 1 percent to $17.56 billion. IBM had previously guided for fourth-quarter revenue growth in constant currency terms to be similar to its third-quarter performance, which was up 2 percent.

One of the key metrics investors will focus on is IBM’s free cash flow. The company has guided for full-year free cash flow of more than $12 billion for fiscal 2024. With this report, IBM is expected to provide its initial outlook for fiscal 2025, which will be closely scrutinized given the changing dynamics of IT spending.

IBM’s performance in the previous quarter was characterized by solid earnings growth, but revenue slightly missed estimates. The company reported a 1.5 percent increase in total revenue to $14.97 billion, with a 2 percent gain in constant currency terms. While that growth was somewhat muted, IBM remained committed to its full-year free cash flow target.

Software Continues to Drive Growth

The highlight of IBM’s earnings in recent quarters has been its Software segment, which has emerged as the company’s primary growth driver. In the third quarter, IBM’s Software revenue surged by nearly 10 percent to $6.5 billion, with strong momentum in its Red Hat business, which grew by 14 percent. Transaction processing software also contributed meaningfully to the segment’s outperformance.

Software now accounts for approximately 45 percent of IBM’s total revenue, a significant increase from the high 20 percent range in 2018. Importantly, IBM’s Software division benefits from a high level of recurring revenue, with about 80 percent of annual Software revenue falling into this category. This provides stability in an otherwise uncertain macroeconomic climate.

Consulting Faces Macroeconomic Challenges

IBM’s Consulting segment has been more challenged, with revenue in the third quarter slipping by 0.5 percent year-over-year to $5.2 billion. The company cited softer discretionary spending by corporate clients amid macroeconomic uncertainty, including geopolitical tensions, shifting interest rate expectations, and inflationary pressures.

That said, while spending has been constrained, IBM has noted that businesses are actively reprioritizing their IT budgets to prepare for generative AI adoption. With the 2024 U.S. elections now concluded and inflationary pressures showing signs of easing, there is potential for a pickup in consulting demand.

Infrastructure and Product Cycles

IBM’s Infrastructure segment, which includes hardware and server products, declined 7 percent in the third quarter to $3 billion, a drop largely attributed to product cycle timing. While Infrastructure remains an important revenue contributor, IBM has increasingly pivoted its business model away from hardware reliance and toward software and AI-driven solutions.

The DeepSeek Factor: AI Disruption and IBM’s Strategic Positioning

A significant topic on today’s earnings call will likely be IBM’s perspective on DeepSeek’s emergence and its impact on AI investment. DeepSeek’s ability to create a competitive AI model at a fraction of the typical cost has sent shockwaves through the AI industry. Companies that have been investing heavily in AI infrastructure, including cloud providers and chip manufacturers, are reassessing their spending plans in light of this development.

For IBM, which has positioned itself as a key AI player with its WatsonX platform and hybrid cloud solutions, the DeepSeek revelation raises critical questions. Will AI spending shift toward more cost-efficient models? Could IBM’s AI and cloud strategy require adjustments to compete in a rapidly evolving landscape? Investors will be keen to hear IBM’s insights on how it plans to navigate these industry shifts.

Stock Performance and Market Sentiment

IBM’s stock had a strong rally in the latter half of 2024, climbing from around $165 in early June to a peak of $239 by December. While the stock has since pulled back from its highs, the recent decline has been relatively modest, suggesting that investors remain optimistic about IBM’s long-term prospects.

Despite this, IBM has faced some revenue shortfalls, missing sales expectations in both the first and third quarters of 2024. This earnings report will serve as a crucial test of whether IBM can sustain its momentum, particularly in the face of growing competition and shifting technology trends.

Key Takeaways and What to Watch For

IBM has not missed an earnings-per-share estimate in any quarter over the past five years, highlighting its operational consistency. However, revenue growth has been less predictable, with fluctuations tied to macroeconomic conditions and shifts in IT spending priorities.

For this report, the key themes to watch include:

- IBM’s software growth trajectory and the sustainability of momentum in its Red Hat and transaction processing businesses

- Signs of stabilization or improvement in the Consulting segment as businesses reassess their IT budgets

- Management’s commentary on AI spending trends and how DeepSeek’s cost-efficient model may impact IBM’s AI and cloud business

- Free cash flow guidance for fiscal 2025, which will provide insight into IBM’s financial outlook and investment plans

IBM’s earnings report today will not only shed light on its own performance but also provide valuable insights into broader industry trends, particularly in AI, cloud computing, and enterprise IT spending. Given the evolving competitive landscape, IBM’s ability to articulate a clear strategy for continued growth will be critical in shaping investor sentiment moving forward.