IBM Grows, Power Systems Slows

April 26, 2021 Timothy Prickett Morgan

The good news, if you are a customer of IBM who wants Big Blue to stick around in the systems business, is that IBM actually saw some growth in its overall business for the first time in two years. This growth was driven in large part by its System z mainframe line, in the first quarter of 2021. The less than good news – but not unexpected – is that the Power Systems business continued to shrink as customers await high-end Power10 systems later this year and low-end Power10 machines early next year.

In the quarter ended in March, IBM’s overall sales were up nine-tenths of a percent, to $17.73 billion. Gross profits rose by 3.6 percent to $8,205, but net income actually fell by 18.7 percent to $955 million. In the year ago period, IBM booked a $1.23 billion tax benefit that pushed it out of what would have been something on the order of $100 million of red ink, allowing it to book a $1.18 billion net income. But right now, rest assured, IBM is financially healthier than it was a year ago.

Systems Group, which is the part of Big Blue that we care about most as The Four Hundred, had a 4.3 percent rise in external sales (meaning to channel partners and to customers) to $1.43 billion; sales of systems to other IBM groups accounted for $189 million, up 27.7 percent and perhaps IBM is stuffing a little extra sales into its NewCo, now called Kyndryl, managed infrastructure business, which it will be spinning off at the end of the year. Analyzing the external sales, systems hardware – meaning servers and storage together – rose by 12.5 percent to $1.13 billion, driven by a 49 percent spike in System z15 sales (that’s at constant currency, not as reported). Operating system sales as reported came to $301 million, according to our model, down 18 percent (again at constant currency). That’s a strange divergence. Systems Group gross profits rose by 12.9 percent to $774 million, and IBM significantly reduced its pre-tax losses, which were $217 million in Q1 2020 and which shrank to a $2 million loss in Q1 2021. In its call with Wall Street to go over the numbers, James Kavanaugh, IBM’s chief financial officer, said that “product cycle dynamics continue to play out” with the Power Systems line and IBM’s various storage products. Neither he nor Arvind Krishna, IBM’s relatively new chief executive officer, said anything more about Power Systems, but the company’s financial report says that Power Systems sales were off 13 percent at constant currency and storage was off 14 percent.

When we pump take into account the exchange rate for IBM overall and pump this data into our model, we think sales of Power Systems actually only had a 10.1 percent decline. The first quarter of 2020 was not a particularly strong one, with sales of $181 million by our estimates, and that was a 33.5 percent decline compared to the first quarter of 2019. In any event, we reckon IBM sold around $163 million in Power Systems iron in Q1 2021. By our model, we think IBM had about $36 million in storage-related sales based on Power iron, down 11.6 percent. That puts the core Power Systems business at $199 million, down 10.4 percent, for the first quarter of this year. This does not include any sales to Global Services for the IBM Cloud to carve up into cloudy slices or for NewCo/Kyndryl to use to provide capacity for outsourcing customers. We have no idea how much this might have been, but it could ne quite large with IBM booking $189 million in intra-group sales of systems hardware in general.

As best we can figure, Q1 2021 was the worst quarter in history for the Power Systems line, at least for those sales that IBM books. As we have said in the past, we think Inspur, IBM’s joint venture partner in China for Power server sales, has a respectably sized and growing Power server business – one that IBM used to have by itself but could not keep because the Chinese government wants technology to be controlled by indigenous companies as much as possible. So as far as we know, the overall Power server business is actually up. And who knows if Google is building its own Power iron, as it says it was doing a few years back.

You would think that the OpenPower Foundation would have some interest in quantifying and qualifying the Power server and storage ecosystem to show it is not as weak as it might seem.

Obviously, IBM has a very large systems business – meaning servers, storage, networking, operating systems, and various systems software. For as long as we can remember, we have torn apart IBM’s financial reports to try to calculate the revenues that this underlying system business actually drives. There is a bit of witchcraft here, of course. As best as we can figure, here is the revenue and gross profit from this underlying “real” IBM systems business, which is much larger than the revenues that Systems Group reports:

Based on our model, IBM’s “real” systems business posted $5.78 billion in sales, down 1.4 percent and accounting for 32.6 percent of its overall revenues, with gross profits of $1.91 billion, down 4.3 percent and accounting for 33 percent of IBM’s overall gross profit. The revenues and margins shown above do not include application server software or database software revenues or support for either, or any other data analytics or application software, either. This is meant to just show the base system revenue and profit stream. And it does not include Red Hat, which we have yet to tear apart and integrate into the model. We will have to take out managed hosting once the Kyndryl deal is done, and will do out best to work Red Hat into the mix at that time later this year or early next to get a better sense of the then-current IBM systems business.

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