Red Hat continues to grow, but IBM’s struggles continue

IBM has been in the midst of a strategy shift with a focus on hybrid cloud and AI since Arvind Krishna was promoted to CEO in last year. Red Hat, the software company it purchased for $34 billion in 2018 has been at the center of it all. With the company reporting earnings yesterday, the financial performance was pretty bleak, but at least Red Hat continues to grow at a brisk pace.

Overall the company announced revenue of $17.62 billion for the quarter, which came in below analysts’ expectations of $17.77 billion, according to a CNBC report. On the bright side, it grew at a very modest 0.3% year over year. That may not sound like much, but positive revenue has been hard to come by for Big Blue in the last decade.

As for the cloud and cognitive software business unit that includes Red Hat, that was up 2.5% to $5.69 billion. At the earnings meeting with analysts after the report hit, CFO Jim Kavanaugh indicated that Red Hat grew 17% for the quarter. “Red Hat revenue growth was 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,” he said, referring to the company’s container orchestration platform.

That was the good news. The bad news is that they need to hire technical talent to keep up with demand and that talent is getting more expensive and cutting into their margins. “With a competitive labor market, this is putting some pressure on our labor costs, including higher acquisition and retention costs, which is not yet reflected in our current pricing. We expect to capture this value in future engagements, but it will take time to appear in our margin profile,” he said.

So Red Hat isn’t the problem, but IBM needs to find ways to squeeze more from its centerpiece company. Holger Mueller, an analyst at Constellation Research says that the company needs to grow Red Hat further by doing a better job of convincing the hybrid cloud market that it’s truly a neutral player and not looking to be merely selling IBM services.

“IBM has not fully managed to position itself as the ‘Switzerland’ for cloud by allowing enterprises to avoid lock-in by using RedHat. It is a valid offering but has not caught the minds of the CxOs out there,” Mueller said.

Meanwhile the company is spinning out its infrastructure services division into a separate company as it announced last year. It’s seen as a move to solidify the company around the cloud and AI strategy, but there will be some financial pain from losing that revenue from the balance sheet when the deal becomes final next month.

Other key parts of the company such as global services was down 5%, while systems revenue was down a hefty 12%. Only global consulting was a bright spot, growing 12%.

IBM is making some progress here, however incrementally, but not enough and not quickly enough. The stock is getting hammered today, down 9.56% at market close. Stockholders clearly want to see more, and while Red Hat is leading the way, the rest of the company continues to lag, and investors aren’t happy.