Power Systems Carries That Weight In IBM’s Third Quarter

October 24, 2011 Timothy Prickett Morgan

Despite the impending launch of new Power7-based machines that came out on October 12, the Power Systems business on which IBM i customers depend nonetheless booked another great 13 weeks in the third quarter of 2011. Even though IBM was short $103 million compared to what Wall Street expected it to do in terms of aggregate sales, profits were right on target and Big Blue was confident enough in the fourth quarter to raise its earnings guidance for the third time this year.

In the quarter, IBM’s sales rose by 7.8 percent, to $24.2 billion, with net income under a little pressure since it only rose by 7 percent, to $3.84 billion. But because IBM loves to buy its shares back from Wall Street because its top brass measure their own success by earnings per share, with that EPS rising 13.1 percent, to $3.19 a pop, all was not just well at Big Blue, but peachy keen. (I personally think there are better things to do with cash, like invest in the business or give larger dividends to stimulate the economy or people’s retirement.)

IBM’s overall systems business had a 6 percent revenue bump as reported, which was up 2 percent at constant currency. Mainframe sales dropped by 5 percent compared to Q3 2010, and the total MIPS capacity that IBM shipped in the current quarter fell by 11 percent. In a conference call with Wall Street analysts, Mark Loughridge, IBM’s chief financial officer, was asked if this was a normal tailing off of mainframe sales, and he said that if you look at the three most recent zSeries and System z rollouts, this one was “right in the middle” in terms of the duration of the sales bump and the tailing off. I don’t quite buy that, given that System zEnterprise 196 machines have only been shipping for a little more than a year and the zEnterprise 114 midrange machines were only launched in July. The cost per MIPS on the zEnterprise 114 machines is a lot lower than on the bigger boxes, so this might be what is really going on. The price gap between high-end and midrange machines has been widening over the past several generations of mainframes. That might be why mainframe sales are slipping a bit earlier than I expected.

Power Systems iron is not showing any sign of slumping, with the overall line seeing a 15 percent revenue bump in the third quarter compared to the year-ago period. Then again, this was an easy compare. I checked, and in the third quarter of 2010, Power Systems sales were off because the entry and high-end machines were only launched in August of that year and everyone knew something was coming. If you do the math, sales of Power Systems in the third quarter of 2011 matched those in the third quarter of 2009 and IBM did not make up for the drop it had in the third quarter of 2010. Loughridge was excited that IBM was able to show 50 percent revenue growth for its high-end Power Systems, but again, it would almost have to. The Power 795 was known to be on deck for 2010 as the third quarter began on July 1, 2010, so sales were no doubt awful for big boxes in that quarter. Yeah, this kind of thinking won’t get anyone any bonuses, but it is the truth.

The important thing for IBM i customers is that Big Blue is happy with its Power Systems sales and lets IBM i run on the machines. It is similarly important that IBM has added 80 new mainframe customers since the System z196 machines started shipping last fall.

The System x/BladeCenter business has similarly drawn level again, with sales up 1 percent in the third quarter. They were up 30 percent in the year-ago period, which is a very tough compare indeed. Storage sales rose by 8 percent. If you add storage software to the storage hardware, the combination was up 12 percent, and that shows again what IBM really cares about–creating hardware platforms that run expensive and profitable software that does complex stuff companies will pay big bucks for. The IBM i platform is one of those quintessential IBM products, albeit more nichey than a storage array with lots of embedded functions.

Overall, Systems and Technology Group had $4.48 billion in revenues in the third quarter, up 3.6 percent, and had $318 million in pre-tax profit, adding a bit to the IBM bottom line. But that is not the point. Were it not for those expensive servers, IBM could not sell its even more expensive software and services. It is almost silly to break server sales from software sales, since they are systems. What would be instructive is to see how much of IBM’s sales for Power and mainframe systems, including all the software and services that gets put on them, stack up against various software and services products that are sold on non-IBM platforms. I would be very surprised if even 25 percent of IBM’s software and services (and I mean core system services here, not all the consulting, integration, and outsourcing work Big Blue does) is on non-Blue platforms.

But, we still talk about Software Group and Global Services as if they are somehow separate. Software Group had $5.82 billion in sales, up 12.9 percent in the quarter, and brought in $2.21 billion in pre-tax income. That’s 30 percent of revenues, which is good business if you can get it. That software business includes the Netezza data warehousing appliance business, which includes IBM blade servers and custom FPGA co-processors and which grew revenues by 36 percent in Q3. The WebSphere brand, thanks to the acquisitions of Sterling Commerce, Unica, and Coremetrics, had a staggering 52 percent revenue boost in the quarter. Database and related product sales grew by 12 percent, while systems management tools bearing the Tivoli brand rose 8 percent. Even Lotus groupware did okay in the quarter, with sales up 6 percent, and so did Rational development tools, with a 7 percent bump. These key branded middleware products, as IBM calls them, had $3.66 billion in sales, up 17 percent. Other middleware (including all the stuff that runs on mainframes and IBM i boxes) added up to $1.11 billion, and grew by 13 percent. Operating system sales made up $582 million and grew at about the same rate.

The Global Services behemoth, which has almost nothing to do with IBM i shops excepting Software Maintenance services for their wares, had $15.2 billion in revenues in the third quarter, up 7.7 percent. IBM’s backlog of services stood at $137 billion, up $2 billion compared to the year-ago period. Global Financing, which is booked separately, actually had a 1.7 percent revenue shrink, to $520 million, in the quarter.

Loughridge was not about to provide any concrete revenue guidance for the fourth quarter. “I think that we have a pretty good hand, outside of STG, which has a pretty tough compare.” That said, Loughridge said that he expected for STG to book a lot of business and profits in the fourth quarter. And that is one of the reasons why IBM is raising its earnings per share guidance for 2011 by a dime to $13.35. Being the cynic that I am, I figure IBM will do a bit better than that and, moreover, was pretty sure of that way back in January.