IBM | Fundamental Analysis | Must Read...

IBM shares fell nearly 10 percent to a seven-month low on Oct. 21 after the tech behemoth released a weak Q3 report.

IBM's revenues rose just 0.3 percent from a year earlier to $17.6 billion, $190 million less than forecasts. But excluding divestitures and foreign exchange rates, the company's revenues were down 0.2%.

Excluding the impending Kyndryl spin-off, IBM's revenue was up 2.5% in the period. Excluding divested businesses and foreign exchange rates, "excluding Kyndryl" earnings were up 1.9%.

IBM's GAAP earnings, which include Kyndryl spin-off expenses, fell 34% to $1.25 per share. Non-GAAP earnings, which exclude those expenses, still fell 2% to $2.52 per share, but beat forecasts by one penny.

IBM's performance was unimpressive, but it was in line with the outlook the company presented at an investor briefing in early October. Did investors exaggerate IBM's disappointing third-quarter report and create a new buying opportunity?

As in previous quarters, IBM reported third-quarter earnings in five main segments: cloud and cognitive software, global business services, global technology services, systems, and global finance.

IBM's cloud and cognitive software revenues grew thanks to double-digit growth in its cloud-related business, which offset low growth in its applications business and lower revenues in its transaction processing business.

The global business services segment profited from strong demand for cloud services, consulting, application management, and global technology services.

However, the Global Technology Services division weakened again, as weak growth in cloud services could not offset the continued decline in the Managed Infrastructure Services segment, which will be taken out by the Kyndryl spin-off.

The company's systems division struggled because of cyclically declining sales of IBM Z and Power systems, and financing revenues declined amid lower demand for financing services and slow sales of used equipment.

Once again, IBM's strengths failed to offset vulnerabilities, and investors were left attempting to find positives in lackluster reporting segments. However, this may all change as the "old" IBM ceases to exist.

After IBM spins off from Kyndryl next week, it will present four new reporting segments: consulting (29% of continuing operations revenue in 2020), software (42%), infrastructure (25%), and finance (2%).

IBM thinks these four segments will make it easier for investors to track the expansion of its faster-growing businesses.

IBM expects the software segment, which includes Red Hat and other hybrid cloud and artificial intelligence services, to be a major growth driver.

It also probably anticipates a streamlined consulting segment to better stand up to faster IT services and consulting companies, such as Accenture and Globant.

IBM's infrastructure business, which includes the legacy systems business as well as other hardware products and services, is likely to remain underperforming. However, IBM's earnings outlook suggests that the company will focus on streamlining its business and cutting costs to improve margins.

IBM believes that after the Kyndryl spin-off, it will deliver "sustained mid-single-digit revenue growth" from 2022 to 2024.

The company believes this growth to be driven by the expansion of hybrid cloud and AI services that can be integrated with public cloud platforms such as Amazon Web Services (AWS) and Microsoft Azure.

IBM probably realizes that it is too late to catch up with AWS and Azure in the public cloud market, but it can still use its large enterprise customer base and Red Hat's open-source software to develop services for the hybrid cloud, which sits between private clouds and public cloud services.

IBM investors will get Kyndryl stock next month. If they keep both shares, they will initially receive a combined dividend equivalent to IBM's current dividend, but then both companies may reduce their payouts.

It would seem that IBM investors should sell their Kyndryl stock immediately since the latter would likely have difficulty keeping up with companies like Accenture, but hold onto their shares of a "renewed" IBM to see if its plans to get out of the crisis work.

Nevertheless, today is not a good time to buy IBM stock. Right now, the stock may seem cheap at 12 times forward earnings, but the company still faces stiff competition from Amazon and Microsoft, which are expanding their public clouds in a hybrid market, and an unstable infrastructure business could derail growth in its software and consulting business.

Investors should wait for IBM to complete its spin-off and for results to improve for a few quarters before believing that the tipping point has arrived. Until then, they should buy other blue-chip stocks, not Big Blue.