Power Systems Shows Growth Again For Big Blue

October 26, 2015 Timothy Prickett Morgan

The good news is that the Power Systems division of IBM‘s Systems Group turned in its third consecutive quarter of revenue growth, something that the Power community of customers, resellers, and software developers most certainly want to see. The bad news is that the rising U.S. dollar compared to other foreign currencies means that overseas sales translate into fewer greenbacks when sales are brought back to IBM’s New York headquarters, masking that growth.

IBM does not report revenue figures for the its Power Systems and System z server lines separately in its financial presentations, but chief financial officer Martin Schroeter said in a conference call last week with Wall Street analysts that Power Systems revenues rose by 2 percent at constant currency, and unlike in past presentations, IBM did not give the reported revenue growth in U.S. dollars. We know that IBM overall faced a gut-wrenching 9 percent currency headwind across its entire business in the third quarter, but we cannot say that Power System sales were as uniformly distributed as for the company overall and just assume that Power Systems revenues as reported were down 7 percent. In fact, we suspect that the decline in reported results for Power Systems would be less than for IBM overall. But it is hard to say.

Schroeter did not give a lot of color on Power Systems sales in the quarter, but did say that IBM “saw growth in both entry-level and the high-end systems, including strong growth and continued customer adoption in Linux-based systems.” He also reminded everyone of the new Power Systems LC line, which is being OEMed from Tyan and Wistron and aimed mostly at scale-out cluster builders who want to deploy Linux on those clusters. We told you about those LC systems a bit two weeks ago, and sadly, these machines are not enabled to run IBM i. But as we have pointed out before, anything that makes the Power Systems line have more revenues and profits helps bolster the IBM i platform for a longer term, and that is a good thing for IBM i shops. “These Power results continue to reflect the progress we are making to transform the platform to align around data and cloud while embracing an open ecosystem,” Schroeter added.

The System z line of mainframes showed a 20 percent bump, year on year, as the z13 ramp continued, and IBM did not, for the first time I can recall in a long time, tout about its MIPS shipments for mainframes. MIPS capacity shipped usually grows faster than revenues, which stands to reason give the Moore’s Law pricing curve and IBM’s desire to have customers stick with mainframes.

IBM’s storage business continues to be under pressure, with its FlashSystem all-flash arrays being a bright spot and high-end disk arrays, which are like the big SMP servers of days gone by being replaced in many cases by clustered disk systems that support block, file, and object storage, seeing declines. IBM did not talk about specific customers, but its overall storage sales were down 14 percent in the quarter at constant currency.

Add it all up, then IBM’s systems hardware group had external sales of customers of $1.49 billion, plus another $121 million of gear sold to other units such as Software Group and Global Services for appliances or hosting needs. Despite all of the cost cutting in recent months, Systems Group posted a pre-tax loss of $24 million. This was better than the $99 million loss it had in the year ago period, mind you, but one-tenth the operating income it had in the second quarter, when it had a big bubble in System z mainframe sales. Basically, IBM needs around $1.6 billion in hardware sales to break even at its current configuration. So far in 2015, Systems Group has done $5.53 billion in total revenues, both inside the company and outside, and has a pre-tax income of $255 million, which works out to 4.6 percent of revenue. About $3.68 billion of that revenue was for servers, $1.69 billion was for storage, the remaining $166 million was for other gear.

We have no idea how much of the revenue stream from Systems Group is coming from the IBM i platform, and it has been years since Big Blue gave any hard figures on the platform formerly known as the AS/400, iSeries, and System i. It would be hard to even venture a guess, to be honest.

We similarly have no idea how much of the $5.92 billion in total revenues that Software Group booked (including $5.14 billion in sales outside of the company) in the third quarter came from IBM i shops. What we can tell you is that Software Group is facing headwinds in transactional sales for software licenses at the largest 250 enterprises that are IBM customers, and that in general, operating systems revenues are under pressure and that Schroeter expected them to continue to be so as far out into the future as he can see. Databases and WebSphere middleware grew 1 point each, but Rational development tools were down 11 percent (and remember, that is at constant currency), Tivoli security and system management software fell by 2 percent, and the broad Workforce Solutions category (which includes Lotus and other products) fell 3 percent. The key branded middleware listed there accounted for just under $4 billion in sales, other middleware (mostly on IBM i and mainframe platforms) drove $1 billion, and operating systems accounted for $533 million.

Global Services had $12.45 billion in sales, utterly dwarfing the rest of Big Blue as usual, and down 11.5 percent as reported. This services giant might be where customers send their Software Maintenance (SWMA) money every month, but it is fundamentally uninterested by and uninteresting to most IBM i shops. But IBM’s actions are driven to a certain extent by Global Services, which accounts for more than half of its revenues, so we have to watch it. Speaking of which, maintenance services drove just under $1.5 billion in revenues in the third quarter, and Integrated Technology Services (where the SoftLayer cloud lives and so does a lot of other things IBM does) had $2.24 billion in sales.

As we have pointed out before, IBM sold off its System x business to Lenovo Group last October, so there are still some tough compares in the real numbers for Systems Group, but taking out System x as well as the Microelectronics Division. We like to look at the core systems business at IBM, ignoring the arbitrary and we think sometimes silly distinctions IBM has made. IBM’s software is not really separate from its services or its servers and storage, and to say it is does not show the actual underlying strength of the IBM business in systems. Even after selling off System x.

If you do a little estimating, as we are not afraid to do, then the core systems business at IBM–including servers, storage, operating systems, middleware, maintenance, and financing–for Big Blue’s own gear, then it is our best guess that IBM brought in around $6.7 billion in systems sales in the third quarter. The core servers, storage, and operating systems accounted for about $2.1 billion of that, by the way. And for the first three months, this core system business has driven $6.9 billion in revenues, and our best guess is at something like an average of 60 percent gross margins across the whole stack. (Margins could be a lot higher, it is tough to say.)

Our point is, International Business Machines is, despite all of its yammering about mobile, social, cloud, and analytics, still a systems company. And slapping OpenStack on top of servers and calling it a private cloud doesn’t change that one bit.

IBM claims that its cloud run rate is now $9.4 billion, with $4.5 billion of that coming from SaaS services, which implies that the remaining $4.9 billion is for infrastructure and platform cloud services plus private cloud infrastructure. Four years ago in the third quarter ended in September, then-private SoftLayer divulged that it had over 100,000 servers and $85 million in revenues. We estimated SoftLayer was on track to do about $400 million in revenues for all of 2013 when IBM bought it for $2.2 billion in the summer of 2013. Assuming that IBM has been growing at a rate comparable to Google, Microsoft, and AWS in the cloud, then SoftLayer should be at somewhere around $1.3 billion a year in revenue. Amazon Web Services is at $6.9 billion for the trailing twelve months, just for perspective.

I think SoftLayer should make a concerted effort to put low-cost Power Systems on its clouds that are capable of running IBM i and AIX and help modernize their installed bases. Make the capacity cheap and cheerful, and make it up in volume and over time. That is what Amazon Web Services does. The price needs to come down over time, not go up, and you can only accomplish that with scale. It would be far better to have 125,000 enthusiastic IBM i customers on a globally distributed slice of Power cloud on SoftLayer than to lose more of these customers to Microsoft Windows. It would not even take that much money, honestly.

For the quarter, IBM as a whole posted sales of $19.28 billion, down 13.9 percent, and net income of $2.95 billion, which would have been off around the same amount had it not been for write-offs that IBM took in the year ago period that wiped out essentially all of its profits.

Wake up, IBM. Build the Power cloud yourself and have partners sell capacity, software, and services for it. You can pump up Power Systems sales by building that cloud and amortize the cost over years–and get customers used to having ready access to lots of capacity, which as AWS shows they will use. Make it cheap and cheerful.

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