Red Hat, a provider of open-source software solutions for enterprises, was acquired by IBM in 2019 as part of the tech giant’s “creative destruction” strategy of dropping mature, low-profit technology businesses and replacing them with emerging high-margin markets like the “hybrid” multi-cloud.
That’s a computing environment that combines multiple cloud providers and clouds—public, private, and software-as-a-service. The technology giant paid top dollar, $34 billion, to buy Red Hat, and the investment is beginning to pay off, as IBM’s recent financial performance demonstrates.
Arvind Krishna, IBM chairman, president, and chief executive officer, heralded Red Hat’s contribution to the company’s turnaround.
“Our third-quarter performance was led by double-digit growth in software, including a re-acceleration in Red Hat,” he said in a statement accompanying the release of the quarter’s financial results.
IBM’s shift from traditional slow-growth hardware to high-growth software markets has helped reignite the company’s revenue growth, boosting profit margins and cash flow. The company’s generally accepted accounting principles (GAAP) gross profit margin was 56.3 percent, up 190 basis points; non-GAAP operating margin was 57.5 percent, up 210 basis points; net cash from operating activities was $9.1 billion; and free cash flow was $6.6 billion.
“Our investments are paying off in software as we’ve repositioned our portfolio in recent years,” said James Kavanaugh, IBM senior vice president and chief financial officer. “In the third quarter, software delivered broad-based growth, representing nearly 45 percent of our total revenue. Our ongoing focus on product mix and our productivity initiatives enable us to continue to drive operating leverage in our underlying profit performance.”
Sidharth Ramsinghaney, director of corporate strategy and operations at Twilio, sees IBM’s continued growth in its software business as confirmation that its restructuring strategy is working.
“IBM’s third-quarter 2024 results reflect the company’s successful pivot from legacy technology provider to an enterprise AI and hybrid cloud leader,” he told The Epoch Times. “The 10 percent growth in software revenue, particularly the re-acceleration in Red Hat, demonstrates that their strategic repositioning is gaining meaningful traction.”
Meanwhile, rising profit margins and strong free cash flow have helped the tech giant attract Wall Street’s attention again. This has sent its shares 42 percent higher for the year, beating the benchmark S&P 500 Index by a wide margin.
However, the company’s shares were down nearly 7 percent around noon on Oct. 24, primarily due to weakness in its mature infrastructure business, which declined by 7 percent, and its consulting business, which remained flat for the quarter.
Still, IBM’s CEO conveyed an optimistic message for the technology giant’s future thanks to the company’s foray into AI businesses. “We continue to see great momentum in AI as our models are trusted, fit-for-purpose, and lower cost, with performance leadership,” he said. “Our generative AI book of business now stands at more than $3 billion, up more than $1 billion quarter to quarter.”
Heading into the final quarter of 2024, the IBM CEO expects fourth-quarter constant currency revenue growth to be consistent with the third quarter, with continued strength in software.
In addition, he expressed confidence in the company’s ability to deliver more than $12 billion in free cash flow for the year, driven by further expansion of its operating margins.
That should bode well for IBM’s ongoing turnaround on Wall Street as it continues returning cash to its stockholders. “With our strong cash generation, we are well-positioned to continue investing for growth while returning value to shareholders through dividends,” Kavanaugh said.
Free cash flow is the money a company retains after paying all expenses, that can eventually flow to a corporation’s stockholders through dividend payouts or share buybacks. It’s among the top numbers that equity analysts pay close attention to when valuing stock.
Ramsinghaney sees IBM’s new strategic positioning as offering more predictable revenue. “The company is strategically shifting its revenue mix toward higher-margin software and AI solutions, which typically offer more predictable recurring revenue streams,” he said.
