An ugly moment for IBM and software stocks

Dear Reader,

Good morning.

Simmy Adelman here with Behind the Markets.

Yesterday, something happened that I think every investor needs to understand.

IBM warned that its second quarter earnings fell short of expectations.

The stock dropped down around 22% on the news.

That was IBM's worst single day since 1987.

But here's the thing.

This isn't just an IBM story.

It's a story about what AI is doing to every company that isn't in the hardware business.

The Real Story Behind the Numbers

IBM's CEO Arvind Krishna sent a letter to investors yesterday morning explaining the miss.

His exact words: "In the last few weeks of June, we saw clients shift their quarterly capex spend toward servers, storage, and memory purchases to secure supply-constrained infrastructure ahead of expected price increases."

Translation: companies panic-bought hardware in June.

Servers, storage, memory — anything they could get their hands on before prices went up.

And because IT budgets are largely fixed, every dollar that went into hardware was a dollar that didn't go to IBM's software, consulting, or mainframe business.

Infrastructure revenue fell 7%, large deals failed to close on time, and by IBM's own admission, they never saw it coming.

The Contagion Spread Fast

IBM wasn't the only one feeling it yesterday.

ServiceNow fell nearly 7%.

Salesforce dropped roughly 5-9%.

Accenture fell 8%.

Cognizant dropped 7%.

Microsoft and Intuit were both down.

The market was asking a very uncomfortable question.

If companies are draining their software and consulting budgets to buy AI hardware, how long does that last?

Chris Beauchamp, chief market analyst at IG Group, put it bluntly: "This is an ugly moment for IBM and software stocks. The big question will be how long the shift to infrastructure and cybersecurity lasts. A few more months might be bearable. More than that and serious questions will be asked all over again about software stocks."

The Bigger Picture

Here is what I think is really going on.

AI is shaping up to be one of the most capital-hungry technology build-outs in history.

Companies know they need to get their hands on hardware now, before prices go up further and before supply gets even tighter.

So they are making a choice.

Hardware first, software later.

And the software companies — the SaaS names, the consultants, the legacy tech firms — are getting starved of budget in the meantime.

This is not a new idea.

Dylan has been talking about this rotation for weeks.

Right now, the companies sitting at the infrastructure layer of the AI stack are winning.

The companies sitting above it — selling software subscriptions and consulting hours — are starting to feel the squeeze.

If yesterday told you anything, it's that the companies supplying the hardware underneath all of this are in a different position entirely.

Every dollar that left IBM's software budget yesterday went somewhere.

It went into servers, storage, and memory.

It went into the physical infrastructure that AI runs on.

And at the very foundation of that infrastructure — the blueprint that every single one of those chips is built on — sits one quiet company that most investors have never heard of.

It doesn't matter which software company wins.

It doesn't matter which hyperscaler spends the most.

Every chip that gets built to meet this demand runs on the same design.

And one company collects a royalty on all of it.

What This Means Going Forward

Now, this may not be permanent.

IBM's Red Hat unit — which sells open source software and cloud infrastructure tools to enterprises — was actually up 11% last quarter.

Their Distributed Infrastructure segment, which covers servers and storage systems, had its best quarter ever, up 37%.

The July 22nd earnings call will tell us a lot more about whether this is a one-quarter air pocket or something more structural.

But here is the main takeaway from yesterday.

AI is not a rising tide lifting all boats.

It is lifting the boats at the bottom of the stack — the chips, the memory, the servers, the power.

And it is taking water from the boats at the top.

The companies that sell you software to run your business are going to have to fight harder for every dollar from here.

Yesterday was the day the software sector learned that AI budgets and software budgets aren't the same thing.

Have a wonderful Wednesday.

I'll see you tomorrow.

All the best,

Simmy Adelman, Editor-in-Chief

Behind the Markets