"Big Blue" IBM (IBM.US) Faces Challenges in Transformation: Mainframe Sales Plunge 42%! Full-Year Revenue Growth Forecast Lowered to 4%-5%

According to Investing.com, on Wednesday local time, IBM (IBM.US) released its Q2 2026 financial report and lowered its full-year revenue outlook, also revising its highly-watched annual software sales growth downward, primarily due to a significant decline in demand for its mainframe business.

In its announcement, IBM stated that total quarterly revenue was approximately $17.2 billion, up about 1% year-on-year, while adjusted earnings per share for the quarter stood at $2.93. Mainframe sales for the second quarter fell 42% sequentially; full-year 2026 revenue is expected to grow by 4% to 5%, lower than its prior guidance of “over 5%”; CFO Jim Kavanaugh further revealed in an interview that the annual revenue growth rate for the software business is expected in the 6% to 8% range.

Looking at each segment: Software growth has slowed significantly. Software revenue increased by only 5% year-on-year, while in the Q1 earnings call the company had clearly projected full-year software business growth at “over 10%.” Specifically, the hybrid cloud platform Red Hat grew by 11%, data business grew by 19%, but transaction processing software (closely tied to mainframes) performed weakly, dragged down by lagging mainframe sales. JPMorgan previously noted that although software accounts for only around 45% of total revenue, it contributes about two-thirds of consolidated profits and is the cornerstone of the company’s profit quality.

Infrastructure business: dragging down the overall performance. Infrastructure revenue declined 7% year-on-year, mainly due to a sharp 42% drop in z17 mainframe sales. In contrast, distributed infrastructure (Power servers and storage hardware) grew by 37%, achieving its best quarterly performance ever—this is clear evidence that customer funds are shifting from mainframes towards AI-related hardware.

Consulting business: stagnant growth. Consulting revenues were flat year-on-year (up 1% at constant exchange rates), indicating that spending on traditional consulting services by enterprise customers is also under pressure as IT budgets are being reallocated.

Core Reason for Underperformance: The “Crowding-Out Effect” of AI

CEO Arvind Krishna admitted in his letter to shareholders that in the final weeks of June, customers suddenly shifted their quarterly capital expenditures to servers, storage, and memory purchases to lock in AI infrastructure amid anticipated price hikes and shortages. The company “did not anticipate the magnitude of capital expenditure reallocation,” resulting in several large deals failing to close on schedule.

The market interprets this phenomenon as the “crowding-out effect” that AI hardware is exerting on traditional software and services—enterprise IT budgets have not grown significantly, but funds are being intensely reallocated within a limited pool: large amounts of funds are flowing into AI computing infrastructure, directly squeezing the share available for software procurement and mainframe upgrades. In a timely report, Goldman Sachs stated that the IBM event “will fully confirm the bear case for the software industry,” and projected that the software and services sector will face widespread selling pressure. Morningstar analyst Luke Yang summed this up as a new trend where “hardware is eating everyone’s lunch.”

Evercore ISI analyst Amit Daryanani noted in a post-earnings report that this guidance cut “is better than market fears.” The week prior, IBM had pre-disclosed preliminary results showing weak infrastructure and related software sales, leading Wall Street to widely expect a formal downward revision of full-year targets. Kavanaugh explained that the adjustment only involves the aforementioned business units, while all others are performing “very strongly.”

In recent years, through acquisitions of Red Hat, HashiCorp, and Confluent, IBM has been striving to reshape itself into a high-growth software company. However, this new strategy has made the company a focal point for investors—there are concerns in the market that AI tools could deliver disruptive shocks to traditional software business models. Notably, despite the pivot towards software, last year’s new mainframe product cycle had significantly boosted revenue; yet in the quarter ended June 30, mainframe sales dropped 42% from the previous quarter.

Accelerating Cost-Reduction Plans to Bolster Free Cash Flow

IBM stated it will accelerate cost-cutting initiatives and maintains its target of an additional $1 billion in free cash flow for the year. Kavanaugh said the company aims to achieve this through reductions in third-party technology spending, optimizing supply chain management, and lowering administrative expenses, and expects total headcount for the year to remain roughly flat.

Industry analyst Anurag Rana said in an interview that the company’s full-year outlook implies “improvement in the second half.” Regarding share price, IBM closed at $205.77 during regular trading, rising about 2% in after-hours trading. However, year-to-date (as of Wednesday’s close), the stock is down 31%, including a single-day plunge of 25% on the day preliminary results were released.

Earlier this month, there were reports that Starbucks is considering replacing software from suppliers such as IBM with in-house tools. In response, Kavanaugh said that Starbucks spends approximately $2 million annually on a certain IBM application, admitting that this application “is highly vulnerable to AI disruption”; however, he emphasized that most IBM software is much more closely tied to enterprise infrastructure and data layers, making it far harder to replace—and therefore, the company’s moat is relatively deeper.