IBM Earnings Preview: What Wall Street's Thinking

NEW YORK (TheStreet) –– Though there continues to be optimism surrounding the deal IBM (IBM) made with Apple (AAPL) earlier this week, second-quarter earnings will continue to show that the company has a lot of work to do to transition its business for the long term.

IBM has seen slowing, if not stagnant revenue growth over the past few years, as it moves into higher-growth businesses such as cloud computing, big data analytics, security and mobile. IBM's growth in the cloud space has been received mostly positively, save for some high-profile losses like the contract with the CIA. Amazon (AMZN) ultimately won that contract, despite IBM's bid coming in cheaper. IBM is targeting $7 billion in cloud revenue by the end of 2015, after having $4.4 billion in cloud-based revenue at the end of 2013.

Though IBM and CEO Ginni Rommetty have made cloud a high priority, with several notable acquisitions in the past few years, it's still a small percentage of the overall portfolio. IBM is expected to generate $97.4 billion in fiscal 2014, according to analysts surveyed by Thomson Reuters. The data shows that IBM was late to investing and recognizing the potential of the cloud, but it has responded in kind.

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IBM has been divesting businesses left and right, moving out of commodity businesses that no longer fit in with the company's long-term goals. During the quarter, IBM divested the customer care business, which had $1.2 billion in annual revenue.

Analysts surveyed by Thomson Reuters expect IBM to earn $4.29 a share on $24.13 billion in revenue.

IBM is also rumored to be selling off its semiconductor business, which is not a profitable venture for the Armonk, N.Y.-based company and hasn't been for years. At its peak, the semiconductor unit sold chips to the console makers, including Microsoft  (MSFT) and Sony (SNE), but it only represented 1% of the company's profit. In the late 1990s, it went into the merchant business to mitigate some expense on the unit and the cost of running the fabrication plants.

The company recently announced it was investing $3 billion over the next five years in two broad research and early stage development programs for chip technology. The research focuses on making semiconductors more efficient for cloud computing and Big Data systems.

IBM's three fundamental units, services, software and hardware (which includes semiconductors and microelectronics) continue to have mixed results, with software being the most profitable. Software accounts for nearly 25% of the company's revenue, and nearly 50% of its total profit.

At this point in IBM's over-100-year history, the company is a cash cow, essentially returning most, if not all of net income to shareholders. IBM is expected to generate $16 billion in free cash flow in 2014, which will be used to fund buybacks and dividends.

IBM is focused on profit, margins and cash, having divested $6 billion in annual revenue since 2012, and $20 billion in annual revenue since 2000. The company continues to remain steadfast that it will deliver $20 a share in earnings for 2015, after having delivered $16.28 a share in 2013. For 2014, IBM has said it expects to earn at least $18 a share, while Wall Street is bearish, expecting $17.88 a share.

Going into the report, analysts are cautious about the quarter, and whether the company can deliver on its $20 a share goal for 2015. Here's what a few analysts had to say.

Cantor Fitzgerald analyst Brian White (Buy, $220 PT)

"After the close this Thursday (7/17), IBM is scheduled to report its 2Q:14 earnings results with a conference call at 4:30 PM ET. In recent quarters, IBM's results have been characterized by revenue misses with lackluster profit performance driven by muted IT spending, weakness in hardware, softening trends in growth markets and other issues. Since the end of 2011, IBM's stock has risen by just 2% compared to a greater than 56% increase for the S&P 500 Index. In our view, either IBM needs to begin demonstrating to investors that the company is turning the corner or we believe a "shake up" at the company could occur."

JPMorgan analyst Tien-tsin Huang (Neutral, $197 PT)

"We expect 2Q hardware revenue to decline in mid twenties, inline with the decline rate in 1Q. We expect steady MIPS and revenue trends in System-z at the bottom of the refresh cycle, while Power systems could continue underperforming at the low end. We also estimate steady low single digit growth in s/w, as full quarter contribution from the Cloudant acquisition should be offset by tough comps. We expect continued mid single digit growth in Key Branded Middleware."

Credit Suisse analyst Kulbinder Garcha (Underperform, $160 PT)

"Our 2Q14 revenue/EPS estimates stand at $24.3bn/$4.33 vs. consensus of $24.1bn/$4.29. We continue to believe that IBM will see declining organic growth due to high mainframe exposure coupled with slower ramp to high value growth in services and software and struggle to achieve 100% FCF conversion. We reiterate our Underperform rating and $160 target price."

--Written by Chris Ciaccia in New York

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