Core Growth Engine Slows Down! Red Hat's underperformance drags down IBM (IBM.US) stock price sharply.

Revenue from two key software categories at IBM (IBM.US) was disappointing, including the closely watched Red Hat division, which has raised concerns among investors who believe these businesses are crucial for the company's growth. The financial report shows that IBM's revenue in the third quarter was $16.33 billion, up 9.1% year-on-year, exceeding expectations; excluding certain items, earnings per share were $2.65, beating market expectations. Sales from the hybrid cloud division, including Red Hat, grew by 14% in the third quarter, a slight slowdown from the previous quarter and below the analysts' average estimate of 16%. Revenue from transaction processing software, primarily used on IBM mainframes for handling business data, decreased by 1%. Chief Financial Officer James Kavanaugh stated on Wednesday that, despite the revenue growth slowing down, "we feel very good about the overall growth opportunities for Red Hat," as the division helps customers manage data and applications across various types of computing devices. Due to investor enthusiasm for the software business, IBM's stock price has risen this year, thanks to the acquisitions of Red Hat and HashiCorp. CEO Arvind Krishna is driving this division to become IBM's largest business, particularly as the consulting business has been impacted in recent years due to customers' concerns about the overall economy. In the third quarter, total software revenue increased by 10% to $7.21 billion, in line with expectations. Analyst Anurag Rana noted that despite this, the results indicate that organic software growth is slowing. Analyst Amit Daryanani from Evercore ISI wrote that investors may focus on the negative results from Red Hat and transaction processing. Following the earnings announcement, Kavanaugh stated in a conference call with analysts that IBM continues to anticipate "around 15% growth for Red Hat, although at the lower end." The stock closed at $287.51 in New York and dropped by about 5.5% in after-hours trading. It has risen by 31% this year up to the close. IBM stated that since mid-2023, its artificial intelligence business has received orders exceeding $9.5 billion, an increase from the $7.5 billion disclosed in its July financial report. Approximately 80% of orders come from the consulting department, with the rest from the software division. Kavanaugh stated that as customers deploy AI projects into production, the company sees more orders converting into revenue. He added that this contributes to the "inflection point" driving growth in the consulting business. Consulting revenue in this quarter increased by 3.3% to $5.32 billion, slightly higher than expected. Infrastructure revenue surged by 17% to $3.56 billion, benefiting from the sales of IBM's new z17 mainframe server model in the second quarter. For the fiscal year ending in December, IBM expects free cash flow to reach around $14 billion, higher than analysts' estimate of $13.5 billion. The company also noted that, at constant exchange rates, revenue growth rate will exceed 5%, in line with expectations.