Let’s Take a Closer Look at IBM’s Systems and Technology Biz

August 9, 2010 Timothy Prickett Morgan

I am not an insider at IBM nor one of the big IT consultancies that get help from Big Blue as they build their economic models of the server business each quarter when the system makers close out their successive quarters. For several years, I have built a model of IBM’s sales of mainframe, Power, and X64 server sales, and as the years go on, deviations in my model (which by necessity are not as solid as IBM’s own numbers) have made it diverge from IBM’s quarterly numbers. I am going to have to start from scratch and build a new model, starting back from 2006.

I am not sure where the issues are, but it could be that IBM’s quarterly percentage growth or decline rates include machines sold internally to other divisions (such as Power Systems iron sold to the Storage Division as the basis of DS series disk arrays, for instance). This and other internal sales of IBM’s various server divisions could, over the course of years, cause big problems in any model that assumed the percentages were for external sales levels when they might be for all sales, internal plus external. Also, the original assumptions I made back in 2006 and 2007 about mainframe, midrange, and X64 sales could be off by a little, but changes can cascade so that four years later, given the data IBM offers out each quarter and my original assumptions, the data in the model no longer fits.

If you have better numbers and you want to share–and I know a bunch of you do this–feel free to send me a note. I doubt I will have time to rebuild my model any time soon.

So in this quarter’s installment of my analysis of IBM’s System and Technology Group, I am going to focus on the areas of the STG business that I have very high confidence in my numbers. While I no longer feel comfortable about how much system sales go into any particular sales bucket, I am much more confident about how much revenue IBM is generating from all of its systems together and how much it is getting from all the other technology it sells–storage, retail store systems, chips, and intellectual property.

Take a look at this chart:

Starting in 2008, IBM showed a pie chart in its STG presentation that showed, in rounded numbers to two significant digits, how much of its STG revenue came from servers, storage, RSS, and microelectronics/OEM technology sales along with the percent changes it has traditionally given out for revenues for its main server lines. (This would all be simpler if IBM just gave out the revenue figures, like Hewlett-Packard does. Then I could focus on analysis, not the black art of guesstimation.) There are a few things to consider when looking at this data. First, even with the buildup in servers in 2007 and early 2008, IBM’s general trend for both system sales and STG revenues overall is trending downward. There are quarterly trends, with the fourth quarter being strong and the first quarter of the next year being weak, as always, but the peaks have been getting shorter and shorter as the years go by.

IBM is, of course, hoping that shipments of the high-end System zEnterprise 196 mainframes and Power 795 servers will reverse this trend in 2010 and perhaps in 2011. (We’ll see about that.) I have my doubts that STG can ever exceed the peak it set in the fourth quarter of 2007 for overall sales, which is probably one reason why IBM merged its Systems and Technology Group and Software Group together in July to create the new Systems and Software Group under general manager Steve Mills. (There are no doubt other reasons, having to do with the increasingly system-level integration of hardware and software that IBM and other IT providers are trying to peddle as an advantage over piece-parts and system integration, the way of the 1990s and 2000s for a lot of big companies.)

The other thing to notice is that all of the non-systems stuff is not doing much better than the systems. Although it has perked up in recent quarters. In the second quarter just ended, storage, retail, and microelectronics products together almost matched system sales. That shows you just how weak IBM is when its mainframe and high-end Power lines are both looking long in the tooth and everyone is expecting product refreshes.

The questions now are: How many big deals at deep discounts with lots of processor, memory, and storage capacity did Big Blue do just to get through the last couple of quarters? And how much of that business ate into potential sales of System z196 and Power 795 server sales?

In the quarter, Systems and Technology Group had total sales of $4.1 billion, with $3.86 billion sold externally to customers and $244 million of products sold to other IBM divisions. Most significantly, STG booked $333 million in pre-tax income, giving it a pretax margin of 8.1 percent. While this is awful compared to the other IBM groups, it was a whole lot better than the $170 million pretax loss that STG posted in the second quarter. When you allocate overhead to STG (it was in the red last quarter bigtime), it probably contributed somewhere around $246.5 million to net income in the second quarter, or about 7.3 percent of profits. Before eliminating the cross-group selling inside of IBM, STG accounted for 16.5 percent of sales. So it is not delivering profits like the other IBM groups. However, the distinction that IBM has been making since 1995, splitting systems from systems software for them, is arguably silly. IBM did this to show off its agnosticism in the software racket.

My guess is that sometime in the not-too-distant future, IBM will talk about system revenues for System z, Power Systems, and System x products, adding the software and hardware together and showing a combined profit margin for the systems. This would be a way to keep people from seeing how unprofitable its basic hardware business is and to shift the focus to how profitable the systems are. IBM can still show how profitable the software it peddles on competitor systems is this way, too.

We’ll see.

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