International Business Machines Corp (IBM)

• IBM's Software segment is accelerating, with strong growth from Red Hat, which delivered 14% growth and is expected to continue similar performance, contributing significantly to software growth. Additionally, IBM expects the acquisition of HashiCorp to close by the end of this year, further boosting software performance. - - -
• IBM's Generative AI book of business is rapidly expanding, now over $3 billion, up more than $1 billion quarter-over-quarter, with approximately 80% in Consulting. This positions IBM as a strategic provider in Gen AI and is expected to drive growth in Consulting as these mid- to long-term deals turn into revenue. - -
• IBM anticipates an upward inflection in growth in 2025, driven by strong performance in Software, anticipated growth in Consulting from the Gen AI pipeline, and contributions from strategic acquisitions like HashiCorp, while maintaining operating leverage and growing free cash flow faster than revenue. - -

• IBM's consulting revenue is flat, impacted by a challenging macroeconomic environment, with clients reprioritizing spending, leading to a delay in consulting growth until the second half of 2025. - , - , -
• Revenue yield from Generative AI consulting projects is lower by about 3 to 4 percentage points compared to traditional consulting engagements, reducing near-term revenue for IBM's consulting business. - , -
• The HashiCorp acquisition will result in dilution, which could impact IBM's ability to grow free cash flow faster than revenue in 2025. -

1. 2025 Growth Outlook
   Q: Is IBM's anticipated 2025 growth sustainable or a one-off?
   A: Arvind Krishna emphasized confidence in sustainable growth for 2025, citing strong organic growth in Software, with 7% organic growth this quarter, not from acquisitions. - He noted that 80% of software revenue is recurring, up significantly over the last few years, indicating real demand. - Mainframe software is expected to maintain mid-single-digit growth next year. - With the announced HashiCorp acquisition and plans for more M&A, supported by increased cash flows, they see further growth opportunities. - In Consulting, despite lower signings this year, they expect a positive turn, particularly in the second half of 2025, as Gen AI projects convert to revenue. - Additionally, the Infrastructure business, including hardware maintenance, is expected to become a tailwind, potentially contributing a 4–5 point benefit. -

2. Free Cash Flow Growth Potential
   Q: Can IBM achieve high single-digit free cash flow growth in 2025 despite the HashiCorp acquisition?
   A: Jim Kavanaugh expressed confidence in growing free cash flow faster than revenue, even with the expected dilution from the HashiCorp acquisition. - He highlighted that IBM has transitioned from a no-growth company to a mid-single-digit growth company over the past three years, improving pretax margins by 700 to 800 basis points. - The company intends to drive operating leverage and feels confident about their strategy and growth opportunities heading into 2025. -

3. Consulting Business Dynamics
   Q: How is IBM's consulting business performing amid shifts toward AI projects?
   A: Jim Kavanaugh explained that while overall consulting revenue growth has been flat, the Gen AI book of business is expanding rapidly, now over $2.5 billion, with about 80% in consulting. - - These AI projects are longer-term and have lower immediate revenue yield, which puts short-term pressure on consulting revenue. - However, they are building a strong backlog that is expected to drive growth in consulting, particularly in the second half of 2025. - The company is focused on becoming the strategic provider of choice in Gen AI services, which they believe will fuel future growth. - -

4. Software Margin Sustainability
   Q: Is IBM's high software margin sustainable?
   A: Jim Kavanaugh affirmed that they are confident in sustaining the strong margins in their software business, which reached 30% this quarter. - The margin improvement is driven by a strategic focus on high-value areas like hybrid cloud and AI, combined with productivity initiatives. - Software now constitutes about 45% of IBM's revenue and two-thirds of their profit. - They see significant headroom to continue expanding margins in software. -

5. M&A Strategy Focus
   Q: What areas is IBM targeting for future M&A?
   A: Arvind Krishna stated that IBM's M&A strategy focuses on hybrid cloud, automation, and data and AI. - The goal is to find acquisitions that fit their existing strategy and offer synergy with IBM's portfolio, leveraging their go-to-market and distribution capabilities. - While not exclusively targeting open-source companies, they consider both open-source and proprietary solutions that align with their strategic areas. -

6. Enterprise Response to Gen AI Models
   Q: How are customers reacting to IBM's cost-efficient Gen AI models?
   A: Arvind Krishna explained that enterprises are interested in Gen AI but are concerned about the high costs of large models. - IBM's approach with the Granite models offers similar performance for specific tasks using smaller models with 8 to 30 billion parameters, resulting in up to 97% cost efficiency. - Customers appreciate the ability to refine models without owing improvements back to IBM, making it an attractive solution for enterprise deployment of generative AI. -

Quarterly guidance for Q4 2024:

• Revenue growth: consistent with Q3 levels, currency a 0.5-point headwind - (no prior guidance)

Annual guidance for FY 2024:

• Revenue growth: consistent with Q3 levels - (no change from “full-year constant currency growth at the low end of mid-single-digit model” - )
• Software growth: low double digits - (raised from high single digits - )
• Software margin: expands by over 1 point - (no change from prior guidance - )
• Consulting growth: similar to Q3 - (no change from low single-digit growth - )
• Consulting margin: flat - (lowered from expands by about 0.5 point - )
• Infrastructure growth: 1-point impact for the year - (lowered from neutral for the year - )
• Infrastructure margin: mid- to high teens - (no change from prior guidance - )
• Operating pretax margin: expansion of about 1 point year-to-year - (raised from expansion over 0.5 point - )
• Free cash flow: greater than $12 billion - (no change from prior guidance - )
• Operating tax rate: mid-teens range - (no change from prior guidance - )
• Currency impact: 1 point for the year - (lowered from 100 to 200 basis points - )
• Productivity initiatives: $3.5 billion in annual run rate savings by end of 2024 - (no prior guidance)