IBM's AI Pullback, Quantum Leap, Confluence Acquisition "Muddies" Earnings Outlook

SPEAKER_1 (0:00)

Joining me right now, Kim Forrest, Founder, Chief Investment Officer at Boca Capital Partners. Good afternoon to you, Kim. Great to see you. And so I take a look here at IBM. Some of your thoughts here.

Kim Forrest (0:13)

Sure. Well, it's a really tough quarter. The third quarter is always the most difficult for enterprise. Well, there's software, but there are also hardware. So we'll call it enterprise IT companies. Why is that? Well, firstly, everybody's out on vacation. So it's really hard to get deals signed in the third quarter because half of the team is missing or whatever. It doesn't matter. But it's always a tough time.

Making it tougher is the rollout of AI.

So it would be a nice theory that companies, because that's what IBM serves, that companies would continue their basic spending while they're developing new AI kind of software and hardware. But practically, that is not what happens. They will cut back on the ordinary kind of just keeping things going, spending. And I think IBM might be suffering from that in this third quarter. And then finally, there's the issue of AI. Well, do they do AI? Kind of sort of, but not really. So they have to lean on quantum. And I have to tell you, I'm a fan of quantum, but I think it's a solid 10 years to 15 years before it really moves the needle in any kind of practical way. So IBM has a tough road for this next earnings announcement.

SPEAKER_1 (1:42)

Yeah, I thought it was interesting that you mentioned quantum. I had that in my notes for you because you said, look, they're ready for it, but I don't really see them in taking off with that for a large scale deployment. What would change the story? Because you do see it at some point, just not right now. What will change that they will have maybe more of a footprint in quantum?

Kim Forrest (2:02)

Sure, well, I think the whole field of quantum is greatly misunderstood.

While it can do really cool things, if you're going to deploy it, you actually have to make sure it's actually doing the thing that you expect. And how do you do that? Well, you take an ordinary computer and you do run lots of model run-throughs about what's happening over on the quantum side. And quite honestly, probably AI has helped quantum kind of get further than it would have, because the chips are so much faster and better. So you need a lot of compute power to prove what's happening in quantum before people are going to actually start building on top of quantum. I know that's really nerdy, but it is a gating factor for quantum being delivered. But IBM is ahead of a lot of its competitors, certainly, in that area.

SPEAKER_1 (2:57)

Look, I mean, it seems that IBM software business has been gaining. They've had a meaningful shift toward higher margins and recurring business. And we have the Red Hat acquisition, and that has brought at least some growth, right?

Kim Forrest (3:12)

Absolutely.

SPEAKER_1 (3:12)

Are the numbers going and the data software growth is looking good? And the 2026 cash flow outlook, one billion is expected in annual increases. And so are things going in the right direction for IBM? I mean, what do you think of it at this price point at 237?

Doesn't necessarily mean if things are going in the right direction, the stock goes up, right?

Kim Forrest (3:37)

Exactly. And it's great that you bring up software. They have been making some gains there. But in the last couple of quarters, the gains have been reducing, right? So it's the change of gains. It's not maintaining that upward mode. It's upward, but not as much as the prior quarter.

So that's a concern. Adding to it, they did a large acquisition of a company called Confluence. And that's going to muddy the water. It's going to make it difficult for analysts to determine if things are getting better or worse. So it's an area that an owner of IBM should pay a lot of attention to this quarter to see if software, and we love margins of software, if that's improving for the company or not.

SPEAKER_1 (4:24)

Yeah. How about Watson X?

I don't really hear that much about it when we talk about AI. I mean, there's certainly a feeling that IBM and AI is something that will help to continue to boost growth going forward for the company. But where does Watson X fall? Is AI a major growth opportunity when it comes to, it helps businesses to develop and deploy and govern these AI applications? Is it good enough?