IBM’s Q3 earnings will bring clarity to the impact of Red Hat purchase

Many questions haunting the investor community will be answered when International Business Machines (NYSE: IBM) reports third-quarter financial results after the regular trading hours on Wednesday. The Big Blue had completed the $34-billion acquisition of open-source software provider Red Hat on July 9, and therefore, investors expect to get some clarity on how the deal has worked out so far.

Red Hat’s fraught billing history had been cited as a risk element by analysts who were critical of the deal. Also, the huge premium paid to the software firm might destabilize IBM’s liquidity, which may force it to cut down on buybacks during the next two years.

Meanwhile, the market could be more forgiving if the deal helps in bumping up IBM’s topline.

When the company reported second-quarter results, it had provided a weak annual outlook, despite exceeding analysts’ projections on both the top and bottom line. The weak guidance had subsequently raised doubts regarding how the acquisition is working out for IBM. The stock, which had gained 4.4% following the results, plunged almost 13% in the next few days.  

Analysts also revised their earnings estimates for Q3, opting to go with more conservative figures. Average analysts’ estimate for IBM Q3 earnings was $3.53 per share immediately following Q2 results. Today it is pegged at $2.67 per share.  

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Wall Street also expects a modest Q3 revenue of $18.22 billion, which is a decline of around 3% from a year ago. Strength in the Cognitive Solutions segment is likely to continue, thanks to the recent flow of investment into it. The partnerships with LA Cyber Lab and the City of Los Angeles will help push revenue growth from this segment to somewhere around 30%.

IBM has been taking extensive efforts to expand its AI capabilities to newer realms including sports systems. According to the latest IDC report, IBM is the leader in the worldwide AI market, with a share of 9.2%. The management might lay out its plans on the AI expansion strategy during the earnings conference call.

Also look out for comments on the legacy hardware business, which has been reeling under pricing pressure and high debts.

In the year-to-date period, IBM shares have gained 23%. The stock has a Moderate Buy rating in the market.

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