IBM Is Worst Performer on Dow as Cloud Services Unit Falters

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(Bloomberg) — IBM fell the most in three months after reporting revenue that missed estimates, with sales in a key unit declining for the second consecutive period.

The quarterly results, released Tuesday after the close of trading, further extend Chief Executive Officer Ginni Rometty’s turnaround plan into its fifth year without significant progress. The company, once considered a bellwether for the tech industry, was the worst performer on the Dow Jones Industrial Average Wednesday.

Revenue in the technology services and cloud platforms segment dropped 5.1 percent from the same period a year earlier, even though executives had said in April that they expected key contracts to come through in the quarter. The unit is a marker for the strength of the company’s push into newer technologies. Total revenue fell to $19.3 billion, the 21st straight quarter of year-over-year declines.

The stock tumbled as much as 4.7 percent in intraday trading Wednesday in New York, the most since April, to $146.71. The shares have lost 7.2 percent this year through the close Tuesday, and have missed out on the technology stock rally that propelled companies like Amazon.com Inc. and Alphabet to records.

Legacy Drag

International Business Machines Corp. has been working since before Rometty took over in 2012 to steer the company toward services and software, and she has pushed it deeper into businesses such as artificial intelligence and the cloud. Still, legacy products like computers and operating system software have been a drag on overall growth. Some investors are getting tired of waiting for the turnaround to catch on. Warren Buffett’s Berkshire Hathaway Inc. sold about a third of its investment in IBM during the first half of this year.

Several analysts cut their price targets on the company.

James Kisner, an analyst at Jefferies, said the “poor earnings quality aims to mask ongoing secular headwinds” in the software business and competitive pressures in services that may result in more investor disappointment. He rates the stock underperform and cut the price target to $125 from $154.

Better Margins

Gross margins in the second quarter were 47.2 percent, slightly beating the average analyst estimate of 47 percent. That’s better than last quarter, when a surprise miss on margins sent the stock tumbling the most in a year.

“We will continue to see, on a sequential basis, margin improvement from the first half to second half,” Chief Financial Officer Martin Schroeter said in an interview.

Operating profit, excluding some items, was $2.97 a share, compared with the average analyst estimate of $2.74 a share. That measure got a boost from tax benefits, which added 18 cents to the per-share number, IBM said.

The company’s cognitive solutions segment, which houses much of the software and services in the newer businesses and includes the Watson artificial intelligence platform, has shown the most promise in recent periods, growing in each of the previous four quarters. Yet sales in the unit fell 2.5 percent in the second quarter.

AI Competition

Watson, for which the company doesn’t specifically break out revenue, might never contribute a significant amount to the company, Jefferies’ Kisner said in a July 12 note.

Competition in the artificial intelligence market is heating up, with major investments from the world’s biggest technology companies, including Microsoft Corp., Alphabet Inc. and Amazon.com Inc. On top of that, hundreds of startups are jumping in.

“IBM appears outgunned in the ‘war’ for AI talent,” Kisner said. “In our base case, IBM barely re-coups its cost of capital from AI investments.”

The company’s total revenue fell 4.7 percent from the same period a year ago, and missed analysts’ average estimate for $19.5 billion.

Oppenheimer & Co. managing director Ittai Kidron said the results show IBM “isn’t out of the woods yet.”

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