IBM Readies Big Power6 Boxes, New X64 Servers

March 10, 2008 Timothy Prickett Morgan

IBM may be mostly a services and software company, but most of the services and software it sells are still, despite all the changes in the IT industry in the past three decades, driven by its own server platforms and the operating systems that IBM creates for them. So in that regard, if you think of services as the extra goodies you used to get when you spent 10 or 100 times as much for a server than you do today and if you think of software as the stuff that used to come with the hardware more or less for free, than maybe Big Blue hasn’t changed as much as the financial results might lead us all to believe.

But change and the pursuit of growth and a new story to tell about how to capture it are what Wall Street always wants to hear about, and it is certainly what IBM’s employees, vested up to their back pockets in IBM shares and maybe up to their gills in the stock market that is driven in part by Big Blue’s success or failure, want to hear, too. And so all of IBM’s top brass, from chairman and chief executive officer, Sam Palmisano, to those who run IBM’s systems, software, and services groups and their supporting execs, all descended on New York City last Thursday morning to tell Wall Street what amounts to giant bedtime story about how 2007 went, how 2008 might be, and how IBM will get to its ambitious profit goals by 2009. (IBM called the meeting an Investor Briefing, but the day-long event was not really aimed at investors so much as those who nudge the investors one way or the other on a stock.)

Because IT Jungle likes to focus on the systems at the heart of the data centers and data closets around the world and then work out from there through the software and services that go into making these systems useful, the most interesting presentation of the day came from Bill Zeitler, the senior vice president and group executive in charge of IBM’s Systems and Technology Group. That’s the part of the IBM that develops, markets, and sells servers, storage, chips, and custom products. Of course, Zeitler saved the most interesting bits for last, just as he was wrapping up his presentation and revving up for the big finish. I will get to these items first, because they are the newsy bits, and then discuss IBM’s view of the systems space.

So here are the two news items. First, the high-end of the Power6 server line, presumably to still be called the System p 590 and 595 and the System i 595, are being launched at the beginning of April. As I explained last week, IBM is gearing up to do some kind of launch during the week that the COMMON System i user group meeting is being held, which runs from March 30 through April 3 in Nashville, Tennessee. Ross Mauri, general manager of the Power Systems division, which creates the Power-based server line, and Mark Shearer, vice president of marketing and offerings for the Business Systems division and formerly the general manager of the System i division before it was merged with the System p line last July to create Power Systems, are both going to be on hand on April 2 for an announcement of some sort. This may or may not be the launching of the high-end Power6-based servers that Zeitler is referring to. I happen to think that IBM should be getting the revamped Power6-based 520 and 550 servers out the door with System i labels–the machines were launched on January 29 with System p labels–and if there are high-end i5/OS-capable machines out in April too, all the better. Zeitler did not say whether the high-end Power6 boxes would have System p, System i, or both labels on them, and this is strictly a marketing and sales matter, not a technical one. It would be nice if IBM just got System i and System p servers out the door at the same time, but they have very different channels and competitive pressures, so given yield issues IBM is having with all of its Power chips, it always staggers launches in a way to maximize profit.

Another way that IBM is maximizing profit is to move development and manufacturing of some of its X64-based Modular Systems machines–formerly know as the System x line–to China. Zeitler said at the New York briefing last week that IBM has a 1,000-person strong development team in China that has put together a new low-end server line based on Intel processors, and these servers “have the cost and margin that nobody else in the market can come close to.” These new entry X64 machines, which presumably will also come in flavors that support Advanced Micro Devices‘ quad-core Opteron processors, will be rolling out in March and April, according to Zeitler.

The margin thing is a big deal to Zeitler and to all of the other top brass at IBM, because ultimately IBM is in it for the profits. Not for the sake of profits, mind you, since no one wants to pay a lot of taxes on profits. No, profits are what buy back IBM’s shares from the open market, and share buybacks are what drives up IBM’s earnings per share, and hence Big Blue’s stock price over the long haul. This, in turn, makes stock-based compensation all the more fattening. With IBM committed to spending in excess of $12 billion this year on stock buybacks, everything that can must throw off cash to fund this expense.

In 2007, Systems and Technology Group did a better job of helping generate cash, even though sales fell. This makes Palmisano and the rest of the IBM board of directors very happy, even if revenues did slide. Here’s Zeitler’s financial report card from 2007, as measured against the long-term model that IBM has for the Systems and Technology Group:

As you can see, IBM wants System z mainframe sales to grow from 1 percent to 3 percent a year, but at constant currency in 2007, mainframe sales actually dropped by 15 percent in 2007. IBM wants its other server lines, including Power and X64 machines, to grow at between 4 percent and 6 percent a year, but sales for its non-mainframe servers only rose by 2 percent. Ditto for storage, which only grew by 2 percent last year, but which IBM wants to grow at between 6 percent and 7 percent. So why is Zeitler not worried about getting fired? Because IBM’s long-term pretax profit growth expectations are for somewhere between 10 percent and 12 percent, and in 2007, Zeitler’s team delivered 24 percent pre-tax profit growth. So sales might have been down, but IBM made more money.

That’s good business, if you can get it, and even better if you can sustain it. This is IBM’s only course of action, really, in a systems, storage, and custom systems market that is expected to grow at a compound annual growth rate of 3 percent per year between 2007 and 2011, to about a $130 billion addressable market by 2011. Servers are only growing at maybe 1 percent, by IBM’s estimates, storage by 3 percent, and custom systems (exotic gear for particular purposes for telcos, retailers, and governments) is expected to grow by 8 percent over that time. IBM’s custom systems business, which Zeitler talked about a year ago (see IBM’s Plan for an Adjacent, Custom Systems Market), is growing at around 20 percent a year compounded annually, and IBM is very pleased with this.

IBM is also very pleased by the shift to server virtualization and consolidation, and as Zeitler has said many times in the past, he believes that IBM will benefit greatly from this trend. The interesting bit is that Zeitler actually quantified how much IBM will benefit from it. For servers that cost $25,000 and less, IBM’s margins on these products are 15 percent lower than the industry average in 2007. (This is why IBM is excited by the margins that can come from development and manufacturing in China, because Hewlett-Packard and Dell, which make a lot of their servers in the United States, can’t shift manufacturing overseas so easily.) For machines that cost between $25,000 and $250,000, IBM’s profits are 25 percent higher than the average in 2007, and this was driven predominantly by the swift uptake of the System p and System i 570 machines that use the new Power6 processors. And at the high-end of the server space, where boxes cost more than $250,000 and where IBM sells mainframes, a lot of Unix gear, and a few System i machines, IBM’s profit margins are 35 percent higher than the industry average in 2007.

Well, at least IBM’s midrange and big iron customers know where their money is going. It is fueling IBM’s X64 volume server business.

At any rate, because of the shift to bigger boxes engendered by virtualization and consolidation, Zeitler believes that Systems and Technology Group can contribute an extra $1 billion in gross profits to Big Blue by 2010.

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