International Business Machines Corp (NYSE:IBM) shares were still down over 6% on Thursday afternoon after the computing company reported mixed earnings for the third quarter.
Jefferies analysts highlighted the contrast between the strong growth in software and the lagging performance in other business areas in a note Thursday.
"Software strength was broad-based, driven by growth acceleration in Red Hat (NYSE:RHT), Data & AI, and outperformance in mainframe software,” analysts wrote.
Significantly, IBM's AI book of business reported a remarkable 50% sequential growth, reaching over $3 billion. Jefferies noted that the AI book of business now stands at more than $3 billion since inception, up $1 billion sequentially.
The composition of this AI revenue is increasingly leaning towards consulting, which now makes up approximately 80% of the overall book, compared to 75% in the prior quarter.
Despite the software gains, IBM faced challenges in its infrastructure and consulting segments. Jefferies pointed out a "big miss in infrastructure," as revenue declined by 7% year-over-year and fell short of expectations by 6%. The consulting segment's revenue also disappointed with a decline of 0.5% year-over-year.
Management cited a "tepid spending environment and weakness in discretionary spending" as contributing factors to the consulting shortfall.
Looking forward, Jefferies revised IBM's revenue outlook downward, predicting a low-single-digit growth for fiscal year 2024. However, they remain positive about software growth, projecting it to strengthen into the high-single-digit range.
"We are constructive on the raise in software growth to strong high-single digit for FY24 as well as FCF guide maintained at (over) $12 billion,” analysts wrote.
IBM shares trade at 24 times the consensus earnings per share for 2025, compared to 30 times for Microsoft and 35 times for Oracle. Jefferies concluded that while “shares could continue to grind higher on further software strength,” concerns regarding consulting and infrastructure performance, as well as the monetization of AI, keep them on the sidelines.