IBM falls on lukewarm growth for red hat software business

International Business Machines Corp. reported disappointing revenue in two key software categories, including its closely watched Red Hat unit, sparking concerns among investors who see those businesses as essential to the company’s growth.

Third-quarter sales in the hybrid cloud unit that includes Red Hat increased 14%, a slowdown from the previous period and below analysts’ average estimate of 16%. Transaction processing software, which handles commercial data largely on mainframes made by IBM, declined 1%.

While revenue decelerated, “we feel very good about the growth opportunities in Red Hat overall,” Chief Financial Officer Jim Kavanaugh said Wednesday in an interview. The unit helps customers manage their data and applications among different types of computing equipment.

IBM shares have climbed this year on investor enthusiasm for the software business, which is fueled by acquired divisions Red Hat and HashiCorp. Chief Executive Officer Arvind Krishna has pushed the unit to become IBM’s largest business, especially as the consulting business has been buffeted in recent years by customer concerns about the overall economy. In the quarter, total software revenue gained 10% to $7.21 billion, in line with estimates.

Still, the results suggest that organic software growth is slowing, wrote Anurag Rana, an analyst at Bloomberg Intelligence. Investors are likely to focus on the negative results for Red Hat and transaction processing, wrote Amit Daryanani, an analyst at Evercore ISI.

For the year ending in December, IBM said free cash flow will be about $14 billion, ahead of analyst estimates of $13.5 billion. Revenue will expand at a rate beyond 5% in constant currency, the company added, in line with estimates. IBM continues to expect “mid-teens growth for Red Hat, albeit at the low end,” Kavanaugh said on a call with analysts after the results were released.

The shares declined about 5.5% in extended trading after closing at $287.51 in New York. The stock had gained 31% this year through the close.

Total sales jumped 9.1% to $16.3 billion in the period ended Sept. 30, the company said in a statement. Profit, excluding some items, was $2.65 per share. Analysts, on average, anticipated earnings of $2.41 per share on $16.1 billion of revenue.

Bookings for IBM’s AI business have exceeded $9.5 billion since mid-2023, the Armonk, New York-based company said. That has increased from the $7.5 billion IBM disclosed during its earnings report in July. About 80% of the bookings come from the consulting unit, with the rest in software.

The company is seeing more of its bookings convert into revenue as customers are putting AI projects into production, Kavanaugh said. This is helping fuel an “inflection” in growth for the consulting business, he added.

Consulting revenue rose 3.3% to $5.32 billion in the quarter, just ahead of estimates. Infrastructure revenue jumped 17% to $3.56 billion, fuelled by the second quarter of sales for IBM’s new z17 mainframe server models.

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