IBM and the its future of AI

 IBM misses on revenue but sees AI leading a new round of growth

BY PAUL GILLIN

IBM Corp., which is typically the first major information technology company to report earnings each quarter, today beat profit expectations and narrowly missed revenue forecasts in its fiscal first quarter but set an optimistic tone for the rest of the year.

The company cited double-digit revenue growth in two strategic business areas — Red Hat hybrid cloud and artificial intelligence — while saying that the demand by enterprises across the globe for AI has significant potential upside for both its software and consulting businesses. Red Hat revenue rose 11% and revenue from data and AI gained 10% from a year earlier.

Total quarterly revenue fell 0.4% from a year ago, to $15.47 billion, below consensus estimates of $15.58 billion. However, earnings of $2.18 a share beat analysts’ expectations of $2.01, although they fell below the $2.31 a share earned in the same quarter last year.

Gross profit margin of 54.9% was up 1.6% and operating profit margins grew 1.4%, to 55.9%. Executives reiterated expectations of between 3% and 5% revenue growth this year. IBM has said both metrics are key performance indicators for 2023.

IBM’s stock fell a little over 1% in after-hours trading following the earnings report.

‘Solid execution’

“Continued solid execution of our AI and hybrid cloud strategy makes us confident in our ability to achieve our full-year expectations for free cash flow and revenue,” said Chief Executive Officer Arvind Krishna (pictured).

IBM reported an 8% jump in software revenue on a constant currency basis, with consulting revenue up 6% and infrastructure revenue down 14%. “We have good momentum in our underlying operational product performance,” said Chief Financial Officer James Kavanaugh.

Although infrastructure revenue fell 14% in line with normal mainframe product cycles, Kavanaugh said IBM is seeing unusual resilience in the online transaction processing market. “We saw an inflection shift in OLTP in 2022,” he said. “We have a much-extended opportunity base to go get that revenue.”

“IBM is hitting the double headwinds of a slowing economy and challenging currency exchange rate developments,” said Holger Mueller, principal analyst at Constellation Research Inc. “The good news is that Red Hat is holding up with 11% growth and IBM is gaining a second leg from the strong momentum of its data and AI portfolio.”

Pundit-IT Inc. Chief Analyst Charles King concurred that the company’s strategic products are holding up well. “Red Hat continues to deliver the goods in software and is also central to the company’s hybrid cloud strategy and solutions,” he said. “The best news was a 24% year-over-year jump in consulting signings among both large and small enterprise customers.”

Generative AI opportunity

IBM executives said excitement over generative AI has a big upside for the company. Krishna said he was “very excited” by the initial reaction to Its May announcement of WatsonX, a product suite designed to help companies more easily build and deploy artificial intelligence models.

The CEO compared WatsonX to Red Hat’s OpenShift, which debuted in 2019 and has roughly doubled in revenue each year. “We have quantified OpenShift at $1.1 billion on an annualized run rate basis,” he said. “It gives you a sense of the excitement we have around these [AI] projects.”

Pund-IT’s King concurred, saying the participation of more than 150 customers in the development of the WatsonX platform “suggests that demand for enterprise-class generative AI solutions will be strong.”

Although the underwhelming market performance of the Watson AI platform since its victory on “Jeopardy!” more than a decade ago has largely sidelined IBM as a market leader in AI, “the company has systematically worked through most of the serious problems that are tripping up new AI platforms,” King said.

He pointed to the company’s work in developing large language model tools and data sets, addressing data privacy and security concerns and building a set of ethical standards to follow in AI development. “IBM’s AI efforts may not be well-known when it comes to generating error-ridden reports and term papers, but the company is steadily adding AI-enabled features and functions that measurably improve the performance of applications and solutions that its enterprise customers depend on,” he said.

Krishna said interest in AI is strong across the globe, with North America, Western Europe and parts of South America leading the charge. “The list of use cases includes IT operations, improved automation, customer service, augmenting human resources, predictive maintenance, compliance monitoring, security, sales, management and supply chain amongst others,” he said. “In the same way we built a consulting practice around Red Hat that is measured in the billions of dollars, we will do the same with AI.”