24/7 Wall St.

International Business Machines Corp. (NYSE: IBM) reported first-quarter earnings results after markets closed on Tuesday. Overall this was a very weak quarter, despite the company managing to pull off a beat on the bottom line, but it seems that the bar was already set very low. As a result, investors sent the stock lower in Wednesday’s session and analysts took the opportunity to readjust their targets.

24/7 Wall St. has included some highlights from the earnings report, as well as what a few key analysts have said afterward.

Big Blue said that it had $2.38 in earnings per share (EPS) and $18.2 billion in revenue, versus consensus estimates from Thomson Reuters that called for $2.35 in EPS and revenue of $18.39 billion. In the same period of last year, IBM posted EPS of $2.35 and $18.68 billion in revenue.

IBM reported its segment revenues as follows:

• Cognitive Solutions revenues were up 2.1% at $4.1 billion (up 2.8% adjusting for currency). This was driven by growth in analytics and security, which include Watson-related offerings.
• Global Business Services (GBS) revenues were down 3% at $4.0 billion (down 1.9% adjusting for currency). Strategic imperatives grew double digits, led by the cloud and mobile practices.
• Technology Services & Cloud Platforms revenue fell 2.5% to $8.2 billion (down 2.0% adjusting for currency).
• Systems revenues totaled $1.4 billion, down 16.8% (down 16.1% adjusting for currency).
• Global Financing revenues were $405 million, down 1.2% (down 2.1% adjusting for currency).

In terms of guidance, the company expects 2017 EPS to be at least $13.80, basically maintaining its outlook for the 2017 full year. Analysts put their consensus estimates around $13.78 per shares, and $78.66 billion in revenue, for 2017.

Credit Suisse’s Kulbinder Garcha commented on IBM in his report:

IBM reported results at a headline level that on most metrics were weaker than expected. While EPS came in at $2.38, slightly above expectations, it was helped by series of one-time items, adjusting for which the results would have missed estimates by 30%. We believe IBM faces fundamental challenges in turning around its business with a combination of top line (legacy MF exposure, cloud impact) and underlying margin pressure. We reduce our below street estimates for 2017/2018 EPS to $13.03 (from $13.42) /$12.50 (from $12.72). Long term, this suggests that FCF is heading to $11 per share. We reiterate our Underperform and $110 target price.

Garcha continued:

We saw revenues of $18.2 billion (down 2.8% year over year) and we believe down 3.4% organically, an acceleration from the second half of last year. We believe this reflects continued pressure from the core business (which at $10 billion was down 11% year over year), more than offsetting growth in Strategic Imperatives (which at $7.8 billion grew 12% year over year), which we believe could continue through 2019. More concerning, we saw gross margin (GM) drop to 44.5%, falling 300 basis points year over year. We believe this reflects the need for continued investment to stabilize the top line and mix shift to their as-a-service business, as we had outlined in our note. We believe the GM pressures could be secular in nature due to competitive and cannibalistic nature of the cloud business. We now project revenues at $78.5 billion/ $76.9 billion (-1.7%/-2.1% year over year) and GM at 46.0%/45.8% in 2017/2018, from 48.9% in 2016.

Separately, Wedbush believes that IBM’s revenue growth and margin degradation challenges help validate Outperform-rated Accenture PLC’s (NYSE: ACN) early moves into digital while aggressively moving away from legacy Services. Relevant factors impacting margins include IBM’s exposure to $60 billion to $70 billion in contract renewals, where in order to retain existing contracts, incumbents are forced to provide 20% or more in pricing resets, as well as the need for incremental onsite presence while delivering digital-based projects. Revenue weakness/cannibalization reflected incremental mix of labor-light delivery models are going through similar challenges.

The margin compression seen in this report continues in both services segments, while robust growth at IBM’s digital offerings reflects a shift from the firm’s legacy services to alternative delivery models, driven by ongoing revenue declines in the firm’s traditional areas.

Wedbush also pointed out that bookings ($7.9 billion) were flat year over year, while backlog ($116 billion) posted a decline of 2% from last year. Management claimed delays within GBS and infrastructure services and contract losses (in Germany) as the driver behind the depressed level of bookings in the quarter.

A few other analysts weighed in on the stock as well:

• Societe Generale downgraded it to a Sell rating from Hold.
• Merrill Lynch maintained a Buy rating but cut its price target to $180 from $185.
• RBC maintained a Sector Perform rating and lowered its price target to $180 from $185.
• Jefferies reiterated a Sell rating with a $135 price target.

Shares of Big Blue were trading down about 5% at $161.62 on Wednesday, with a consensus analyst price target of $169.15 and a 52-week trading range of $142.50 to $182.79.