IBM "Beats" Despite 17th Straight Revenue Decline; Margin Miss; Spike In Net Debt

After 16 consecutive quarters, or 4 years, of declining annual revenue growth, there were some whispers that this could be the quarter IBM finally breaks the trend. Alas, it was not meant to be, and moments ago IBM reported Q2 revenues of $20.24BN, which will beating consensus of $20.03BN, was still 2.8% lower than a year ago.

 

The breakdown of the declining revenue was as follows:

  • Technology services & Cloud platforms rev. $8.86b vs $8.4b q/q, down 0.5% y/y
  • Cognitive solutions (includes software) rev. $4.68b vs $4.0b q/q, up 3.5% y/y
  • Systems rev. $1.95b vs $1.7b q/q, down 23.2% y/y
  • Business services rev. $4.26b vs $4.1b q/q, down 2% y/y

But more troubling is that despite the relatively modest drop in revenue, GAAP profit tumbled 27% to $2.61BN, with Net Income plunging 29% to $2.5BN, to a big extent as a result of a 2% drop in gross profit which dropped to 47.9%. Even non-GAAP did not help, with adjusted profit dropping 25% and non-GAAP margin of 49.0% missed Wall Street expectations of 49.3%.

Still, thanks to Wall Street's generosity, EPS estimates which had constantly declined into quarter end, IBM beat consensus of $2.89, reporting $2.95 in bottom line. How did it do it? The same way it has always beaten on the bottom line for the past several years: by constantly dragging its effective tax rate ever lower rate as has been the case for the past decade, shown clearly in the chart below.

 

But what may be most troubling is that in a quarter in which IBM barely spent anything on buybacks, traditionally the biggest source of upside for its stock, spending only $0.8bn on repurchases, when coupled with the $1.3 billion in dividends, IBM posted the biggest one quarter increase in net debt since Q1, as net leverage rose from $31.2BN to $34.5BN, the highest net debt print since Q3 2014 when concerns about a credit downgrade of the company first emerged. The reason? IBM's recent M&A spree:

“In the first half of 2016, we grew our R&D investment, closed 11 acquisitions for more than $5 billion and invested nearly $2 billion in capital expenditures, while returning more than $4 billion to shareholders through dividends and gross share repurchases,” said Martin Schroeter, IBM senior vice president and chief financial officer. “These investments are key in helping us build new markets and maintain our leadership in enterprise IT.”

The only problem is that so far these acquisitions have not resulted in either a notable revenue pickup, nor - certainly - in an increase in profit or cash flow.

We would be watching IBM's net debt very closely.  We have a feeling the rating agencies are.