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IBM looks to cloud as its largest business unit continues to falter

International Business Machines Corp.'s pivot towards a hybrid cloud future showed signs of early success in the third quarter and could eventually offset continued declines in systems hardware sales, analysts said.

Although the company's stock remains down since IBM's Oct. 16 earnings report, the addition of open-source software firm Red Hat Inc. boosted IBM's newly reorganized cloud and cognitive software segment, which brings together both cloud and data services. It also helped to offset declines in the company's global technology services segment, its largest unit by total revenue, and the legacy systems segment, which includes both systems hardware and operating systems software.

Analysts said this shift is likely to continue, with cloud services eventually making up for any remaining drag from lost hardware sales. IBM closed on the Red Hat deal in deal in July. The company had announced a reorganization of its corporate segments and a renewed focus on a hybrid-cloud strategy in March as it prepared for the deal closing.

"One of the reasons IBM's core global technology services is declining is because a lot of companies' workloads are now being shifted from on-premises offerings to the cloud," explained David Tsui, senior director of S&P Corporate Ratings' U.S. Technology sector. "The global technology services unit manages infrastructure and provides support services for those hardware and software, so when it is migrated to the cloud the need for said services declines. This workload migration to the cloud is where Red Hat and its platforms come in."

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However, the integration of Red Hat and the broader market shift to the cloud will take time, Tsui noted. Some legacy IBM customers may prove more reticent to move to the cloud model, creating some near-term uncertainty about revenue trends.

"Our expectation is that this will continue to be a headwind, at least in the short term, but if the hybrid cloud infrastructure and IBM's position in the market solidify they could be handling more of the customers' infrastructure as well," Tsui said.

Frank Gens, a senior vice president and senior analyst at research firm IDC, called the third-quarter results positive but said the next year will be important for proving IBM's cloud strategy.

"While its pivot to the cloud-centric market is still not complete, the financials showed positive signs," Gens said. "The next 12 months will be critical as IBM attempts to scale customer adoption of these offerings — especially its revamped cloud portfolio — to finally drive sustained top-line growth."

Gens said IBM must continue growing its cloud business so that it can absorb negative-to-flat growth in other parts of the business. Red Hat's addition will play an instrumental part in this process, provided it can maintain the revenue growth it experienced in the third quarter, he said. Gens pointed to Red Hat's market status and under penetration in certain IBM markets as two signs that it could continue its positive growth trajectory.

"Red Hat has established itself as a leading player in the distributed cloud world, aggressively leveraging and contributing to key open-source standards," Gens said. He also pointed to growth opportunities for Red Hat with IBM's market research customers, noting IBM's plans to bring the service to markets where it has little presence today.

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