Power Systems Eating Into Mainframe Sales

January 23, 2012 Timothy Prickett Morgan

IBM closed out 2011 on a somewhat somber note in terms of hardware sales, but not because of the Power Systems line. That’s good news for any customer that relies on Power Systems, and so is the fact that Big Blue is stealing away business from Unix rivals Hewlett-Packard and Oracle, and so is IBM’s frank admission that Power7-based machines are also taking share away from System z mainframes in the enterprise segment of the server racket.

IBM reported its financial results for the fourth quarter of 2011 after the market closed last Thursday, and because of currency fluctuations due in large part to the financial crisis in the Eurozone, the company’s booked revenue was about $300 million lower than it expected, up only 1.6 percent to $29.5 billion. IBM is all about profits and generating cash to buy back shares and pay dividends, so the fact that net income rose by 4.4 percent to $5.49 billion was no doubt more important to new IBM president and CEO, Ginni Rometty, who took over running the company on January 1.

“We had a strong fourth-quarter performance, capping a year of record earnings per share, revenue, profit and free cash flow,” Rometty said in the traditional canned statement that IBM’s CEO makes when financials are announced. “We delivered outstanding results in all four of our strategic initiatives for the quarter and the year, as we continued to realize the benefit of our long-term investments in growth markets, business analytics, Smarter Planet solutions and cloud. We are well on track toward our long-term roadmap for operating earnings per share of at least $20 in 2015.”

The company is projecting EPS of at least $14.85 in 2012, up 10.5 percent from 2011 and if history is any guide and if the economy holds up, Big Blue will almost certainly raise that guidance as the year rolls on.

For IBM i customers, the health and wealth of Systems and Technology Group, which is still operationally somewhat separated from Software Group even after these two parts of IBM’s systems business were united a year and a half ago, is a big deal. And how well or poorly the Power Systems division does matters particularly, even if the IBM i platform is probably a small portion of that overall business these days. As long as Power Systems is growing and making money, IBM is not looking around for some place to make cuts there.

In the fourth quarter, IBM said that Power Systems sales rose by 6 percent, and until Gartner and IDC put out their respective server sales and shipments until maybe next month, we won’t know if that is better or worse than the server market at large. In a conference call with Wall Street analysts going over the numbers, Mark Loughridge, IBM’s chief financial officer, said that IBM had 350 competitive takeouts with Power-based systems against HP and Oracle in the fourth quarter, and that these deals generated more than $350 million. IBM did over 1,000 such deals in 2011, and they generated more than $1 billion in revenues initially and, if all goes as history tends to, these customers will spend many more billions on IBM wares and services.

IBM’s System z mainframe business swooned, with revenues down 31 percent even with an aggregate MIPS shipment decline of only 4 percent. IBM has clearly ran out of eager mainframe buyers for its big zEnterprise 196 machines launched in July 2010 and the zEnterprise 114 “midrange mainframes” that followed them in July 2011 were never going to be big revenue generators. Loughridge said that profit margins for the System z line were up despite the hardware decline because of “a higher proportion of microcode upgrades,” and I am not really sure what he means by that, but if it is true, then mainframe microcode must be one very expensive piece of software from Big Blue. Maybe he meant that customers were spending more on mainframe systems software?

In the question and answer session following Loughridge’s prepared remarks, IBM’s CFO said that IBM gained share in 15 of the 16 major product segments it operates in, and that mainframes were the one where it lost share. And in a rare moment of unscripted honesty, Loughridge admitted that IBM’s mainframes lost share in the enterprise segment of the server market. “And who do you think we lost share to?” he asked rhetorically. “Power series, our own product line.”

Even IBM can’t stop calling it pSeries. . . .

Not surprisingly, IBM’s System x and BladeCenter business using X86 processors didn’t do so well in the fourth quarter, with sales down 2 percent. Intel is late getting its “Sandy Bridge-EP” Xeon E5 processors to market, which were widely expected last fall, and hard disk shortages because of the tragic flooding in Thailand are also having an impact on all server makers. Loughridge did not elaborate on whatever is going on with IBM’s X86 business, except to say that he believed that the 2 percent revenue decline was in line with the market.

IBM’s storage hardware sales fell by 1 percent in the fourth quarter, but storage software for various arrays and systems shot up by 30 percent, so the combined storage-related revenue stream was actually up 5 percent in the quarter.

For all of 2011, Systems and Technology Group had just a smidgen under $19 billion in sales (up 5.6 percent from 2010) and pre-tax income of $1.6 billion (up a much better 12 percent).

Loughridge said that IBM’s hardware business will face a tough compare in the first half of 2012, but that with new product announcements expected in the second half of the year, Systems and Technology Group should be able to pull out mid-single digit revenue growth this year with double-digit pre-tax profit growth. He did not elaborate what those announcements might be, but we know new Xeon E5 servers are coming in the spring and it is reasonable to expect Power7+ kickers this year and maybe even a mainframe processor upgrade.

The soft side of Big Blue

The bulk of the black ink that hits IBM’s bottom line comes from Software Group, which posted $7.65 billion in revenues in the fourth quarter, up 8.7 percent. The software portion of IBM’s product lines (which includes Netezza data warehouse appliances, paradoxically, but not some systems software) had a pre-tax income of $3.7 billion, an increase of 12 percent over last year’s fourth quarter. WebSphere middleware sales were up 21 percent, Tivoli security and systems management sales were up 14 percent, and information management (database, data warehousing, and analytics tools) saw a 9 percent increase. Rational development tools were up 4 percent, and the Lotus collaboration products posted a 2 percent decline in the quarter. These five key branded middleware segments accounted for $5.2 billion of the quarter’s sales, and operating systems accounted for $688 million.

In the 12 months of last year, Software Group had 24.9 billion in revenues, rising 10.9 percent partly through organic growth and partly through acquisitions from the prior several years. The group brought in just a hair under $10 billion in pre-tax income, which was only up 5.3 percent compared to a year ago. So there’s some margin pressure in there. So expect some more divestitures like the sale of the iCluster product line to Rocket Software, which happened at the end of 2011.

In Q4, IBM’s Global Services leviathan grew sales by only 2.7 percent, to $15.33 billion, but it was able to jack up profits considerably by chasing higher value business, according to Loughridge. I also happen to think IBM is offshoring more of this work from the United States and Europe to cut costs, but IBM never talks about this and ducked questions on it last week. For all of 2011, Global Services had $60.13 billion in sales, up 6.6 percent. IBM exited 2011 with a $141 billion backlog, and about 70 percent of its runout from that backlog that comes due in 2012 will deliver 3 percent revenue growth this year for Global Services if it doesn’t make even one more sales call. IBM is feeling pretty confident about services–most of which IBM i shops don’t consume.

I have said it before and I will say it again. If we want to save the IBM i business, we have to convert it from being a hardware sale to a services contract. And I am not talking about leasing. I am talking about on-premise and public clouds running IBM i and offering live migration, utility pricing, and all the modern ways of computing.