IBM’s Red Hat Growth and Potential Risks

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International Business Machines Corp. is making strides in the artificial intelligence field with its WatsonX initiative. However, analysts are shifting their focus to other areas of IBM’s business that are currently generating significant revenue.

When IBM releases its second-quarter earnings after market close on Wednesday, attention will be drawn to the company’s open-source software platform, Red Hat. UBS analyst David Vogt expresses skepticism about the potential for growth in the second half of the year.

Vogt emphasizes the importance of monitoring Red Hat’s performance in the second quarter, as management expects it to contribute significantly to the projected 5-point software growth in 2023. However, Vogt remains cautious and predicts Red Hat’s growth to be around 11% for this period. To meet the company’s guidance range of 11% to 13%, there would need to be a substantial acceleration in the second half of the year. The analyst raises concerns about potential risks, such as “push outs and reduction in contract lengths,” which have been reported by other Linux companies.

Furthermore, Red Hat is facing criticism regarding its new source-code policies. These policies have reportedly made it challenging to develop operating systems that are compatible with Red Hat Enterprise Linux.

While many companies are eager to showcase their involvement in AI, IBM has been promoting its WatsonX enterprise-AI offering. However, JPMorgan analyst Brian Essex believes that its financial impact in the near term may not be significant, despite acknowledging it as an encouraging product.

It remains to be seen how IBM’s recent ventures into AI and its performance in Red Hat growth will shape the company’s future trajectory.

IBM’s AI Contribution Predicted to Come in Next Year

Analysts have shared mixed opinions about the potential impact of IBM’s artificial intelligence (AI) efforts. According to Essex, meaningful revenue from AI is not expected until next year at the earliest. Investors, he suggests, will need to see evidence of traction before fully supporting IBM’s AI endeavors due to the company’s past results with traditional AI endeavors.

IBM shares have been given a neutral rating by Essex, with a target price of $145.

Stifel analyst David Grossman believes it is too early for WatsonX, an AI product from IBM, to contribute to material growth. However, Grossman states that the product integrates IBM’s core technologies effectively and appears to be a solid open-AI platform.

Given IBM’s legacy Watson initiative, increasing security concerns, and enterprise positioning, Grossman believes that the company will have a seat at the enterprise AI table. He recommends IBM as a defensive market hedge for dividend-sensitive investors, giving the stock a buy rating and setting a $140 price target.

Grossman also comments on IBM’s recent earnings report and highlights that while the company has experienced notable margin expansion over the past few years, greater consistency and more favorable macro conditions are needed for fundamental upside and multiple expansion.

In late June, IBM confirmed the acquisition of cloud-based business software company Apptio for $4.6 billion in an all-cash deal. Grossman estimates that Apptio could contribute up to 40 basis points to software growth and less than 20 basis points to IBM’s overall growth rate.

FactSet data predicts that IBM will report second-quarter earnings of $2.02 per share on revenue of $15.57 billion. This is compared to earnings of $2.31 per share on revenue of $15.54 billion in the year-ago period.

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