"Only 2% of the company's software could be replaced by AI-powered applications," IBM CEO Arvind Krishna said, trying to calm investors after a rough quarter. Software makes up 45% of IBM's total revenue and carries the highest profit margins. Transaction processing software already saw a 9% drop in revenue last quarter.
Krishna pointed to a customer like Starbucks, which pays IBM $2 million a year for what he called a "10-year-old piece of software." Starbucks is phasing out the Tririga lease management system, an IBM acquisition from 2011 that the company has scheduled for support termination in 2027. "That is a big component of that 2% I talked about," Krishna said.
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But the rest of IBM's software lineup is built for the AI era, Krishna argued. "The rest of our software really helps people get ready for AI, unlocking data in real time, reducing the cost and complexity of managing it," he told CNBC. The CEO also said that because most of IBM's software is infrastructure software - not applications - AI should actually help the business. "I think it'll be a tailwind for us," he said.
During the second quarter, mainframe revenue declined by 42% as clients redirected their budgets toward data center hardware. One reason: memory prices are rising because of demand from AI chips, which made the mainframe upgrade less appealing. The slump hit IBM's stock hard, dragging it down 30% for the year so far. That is worse than the broader software sector - the iShares Expanded Tech-Software Sector ETF (IGV) dropped 17% over the same period.
The software that runs on those mainframes is also feeling the pain. But Krishna said that lag is temporary. "The software on that tends to lag the hardware capacity, and I do think that if we give it another year, you'll find the software will catch back up," he said.
IBM still says it will add $1 billion to free cash flow in 2026. But the finance chief, Jim Kavanaugh, now expects software revenue to grow 6% to 8% for the year - down from the double-digit growth he predicted in January. Krishna said, "About 75% of the deals that slipped from the second quarter should return before year end." Jefferies analysts wrote in a Thursday note that they recommend buying the stock but "would avoid giving full credit for the maintained guide until a larger portion of the slipped activity is reflected in reported results."
Despite the near-term headwinds, IBM's leadership remains confident that the company's strategic focus on hybrid cloud and AI will pay off. Krishna's reassurance that only 2% of code is at risk from AI aims to alleviate investor fears about the disruption of IBM's lucrative software business, which continues to transition away from legacy mainframe systems.
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