IBM crushed estimates and raised guidance, then watched investors torch the stock anyway - because Red Hat, the metric that investors were keen to see outperform, came up short.
The tech stalwart posted adjusted earnings of US$2.65 per share for the third quarter, beating the $2.44 consensus by $0.21 - yet the stock fell 5% in after-hours trading on Red Hat growth concerns.
Shares closed at $288.15 before the results, capping a 30% rally year-to-date that left the stock trading at a premium valuation heading into the print.
Beats across the board
Revenue hit $16.33 billion versus expectations of $16.09 billion, up 9% year-over-year.
Mainframe sales jumped 59% to deliver the highest third-quarter Z-series revenue in nearly two decades, generating $2.3 billion in hybrid infrastructure revenue.
Software revenue grew 10% to $7.2 billion, matching estimates, with automation up 22% and Red Hat bookings growth at 20%.
Consulting revenue reached $5.3 billion, up 2% in constant currency and edging past the $5.26 billion estimate, though the pace continues trailing peers.
Quarterly free cash flow hit $2.37 billion, beating the $2.21 billion forecast, as operating pre-tax margin expanded 200 basis points year-over-year to 18.6%.
Adjusted EBITDA grew 22% to $4.6 billion with margin expansion of 290 basis points.
Total debt climbed to $63.1 billion, up $8.1 billion year-to-date, driven partly by the $6.4 billion HashiCorp acquisition that closed in February and is fuelling the automation segment's surge.
Generative AI contributed over $1.5 billion in consulting signings during the quarter, helped by an October 7 partnership with Anthropic to integrate Claude AI models into IBM's software portfolio.
Red Hat an investor red flag
The problem was Red Hat's hybrid cloud revenue, which grew 14% - down from prior quarters and below the 16% analyst estimate investors were counting on.
Morgan Stanley had warned ahead of earnings that the firm "wouldn't be chasing results here" as IBM shares traded at a premium to peers.
Markets wanted Red Hat acceleration to justify IBM's 30% year-to-date rally, but the company delivered everywhere except the one metric investors cared about most.
Yet IBM CEO Arvind Krishna remained upbeat on the Q3 results.
“We accelerated performance across all of our segments, and again exceeded expectations for revenue, profit and free cash flow,” Krishna said.
"Clients globally continue to leverage our technology and domain expertise to drive productivity in their operations and deliver real business value with AI.
“The company's AI book of business now stands at $9.5 billion, up from $7.5 billion last quarter.”
Guidance
IBM tempered its full-year constant currency revenue growth to "more than" 5% from "at least" 5%, while free cash flow guidance increased to $14 billion from $13.5 billion.
Its operating pre-tax margin is expected to expand by over a point, with adjusted EBITDA growth in the mid-teens and currency tailwinds adding roughly 1.5 percentage points to reported revenue.
