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Red Hat rescues IBM from otherwise grim Q3 ahead of “Kyndryl” spinoff.

IBM revenue climbed just 0.3% in Q3, sending shares tumbling after hours as the company gears up to divest its $19 billion managed infrastructure services business, which will be branded Kyndryl — a move was announced on October 8, 2020 but only approved by its board of directors on October 12, 2021.

(The idea is to shift IBM out of the low-margin managed infrastructure realm and more into higher-margin software. Per its initial forecasts, IBM will bring in less revenue post-spinoff but almost the same free cash flow as it did before. With the unit a key source of the disappointing results, the move makes sense.)

A sharp slump in mainframe sales (IBM Z sales crashed 33% on a largely cyclical basis; a decline that was somewhat offset by storage growth of 11%) also particularly hurt the bottom line. CFO Jim Kavanaugh noted: “The infrastructure segment, which is high-value, mission-critical covering our mainframe business and infrastructure support business, was projected to be flat over time as it follows innovation cycle. As we bring out innovation next year, we firmly believe and [are] confident that we’re going to grow there.”

Revenues for the nine months ending September 30, 2021 were $54.1 billion, up 1.6%.

Net income for the same period was $3.4 billion, down a stinging 19% year-on-year. (IBM blamed, in part, “the impact of $0.7 billion of transaction costs associated with the Kyndryl separation”.)

IBM’s cash balance meanwhile fell $6 billion. Explaining why on an earnings call, CFO Jim Kavanaugh said: “Over the same period, our debt is down $7 billion. In addition to debt reduction year to date, we’ve used $3 billion for acquisitions and over $4 billion for shareholder returns through dividends. Our solid cash generation and disciplined financial management provides the fuel to invest in our business and pay an attractive dividend.”

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Much of the heavy lifting was done by Red Hat.

Red Hat revenue was up 17% “driven by double-digit growth in both infrastructure and application development and emerging technology. And we had more than 40% growth in OpenShift recurring revenue” as Kavanaugh noted, adding that IBM now has “over $8 billion in software cloud revenue over the last year, which is up 28%.”

IBM added over 180 Red Hat client engagements during the quarter, bringing total Red Hat-related signings to nearly $3.5 billion since the acquisition and as IBM CEO Arvind Krishna put it on the earnings call “the one [unit/business] that performed exactly according to what [sic] we wanted was Red Hat.”

Not unexpectedly, IBM executives noted that over the past 18 months customers have expressed a “a preference for opex over capex… This continues to pressure perpetual licenses in favor of more consumption-like model.”

Shares fell 5% after hours.

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