IBM’s third-quarter rebound: deferred orders come through, but 2027 growth still needs acquisition support

Why didn’t the third-quarter beat lead to stronger fourth-quarter guidance?

IBM’s third-quarter revenue was $17.104 billion, up 4.7% year over year and above the consensus estimate of $16.821 billion. Non-GAAP earnings per share of $2.96 also exceeded the consensus of $2.85. About two-thirds of the transactions deferred from the second quarter closed this quarter, helping results rebound.
The completion of those orders did not translate into a higher near-term growth bar: according to the earnings call, fourth-quarter revenue guidance was about $20.3 billion and earnings per share guidance was $4.55–$4.60, below consensus estimates of $20.45 billion and $4.62, respectively.

Third-quarter software revenue growth at constant currency rose to 9% from about 5% in the second quarter, with organic growth contributing more than 4 percentage points. Red Hat grew 11%, but transaction processing grew 10%, driven largely by the completion of about $200 million in deferred orders; excluding those orders, Morgan Stanley estimates that its revenue declined by a low-single-digit percentage year over year.
The divergence remains pronounced: Confluent grew strongly, but the bank estimates that revenue from both the data and automation businesses declined year over year excluding acquisition contributions. The company’s target of about 7% full-year software revenue growth implies about 6% constant-currency growth in the fourth quarter; the bank breaks that down into roughly 2 percentage points of organic growth and 4 percentage points from acquisitions.

Third-quarter gross margins for software, consulting and infrastructure fell by 60, 190 and 50 basis points year over year, respectively. Software was diluted by the consolidation of Confluent; consulting faced a higher comparison base and increased investment in digital assets; and infrastructure saw lower revenue from high-margin Z mainframes, while distributed infrastructure revenue grew 32%, lowering the business mix’s gross margin.
Profit improvement came mainly from expense savings, while a lower tax rate contributed $0.07 to earnings per share. Morgan Stanley expects overall gross margin to fall 10 basis points year over year in the fourth quarter, but cost cuts to lift pretax margin by 160 basis points, indicating that earnings expansion depends more on operating efficiency.

The company raised its 2026 target for the increase in free cash flow excluding the effect of financing receivables, from a year-over-year increase of about $1 billion to more than $1 billion. On that basis, the bank calculates a full-year figure close to $16 billion, requiring $8.1 billion in the fourth quarter, or 51% of the annual total, consistent with the average seasonal share over the past three years.
But actual third-quarter free cash flow on that basis was $3.027 billion, below the bank’s forecast of $3.534 billion. The bank believes the fourth-quarter target remains achievable, mainly through EBITDA growth and productivity savings converting into cash, while absorbing higher cash taxes, capital expenditure and net interest expense.

Management set a target of 5% constant-currency revenue growth in 2027. Morgan Stanley has already assumed that organic software growth accelerates from about 2.4% this year to 8% next year and factored in a stronger infrastructure cycle, yet still does not reach 5%; the bank therefore sees additional acquisitions as key to closing the growth gap.
The bank raised its earnings-per-share forecasts for 2026 and 2027 to $12.43 and $13.46, respectively, and raised its price target from $238 to $240 on higher free cash flow forecasts. Its valuation still uses 14.4 times 2026 price to free cash flow, and it maintained its “Equal-weight” rating: this quarter’s recovery improved the earnings outlook but has not changed its assessment of next year’s growth hurdle.