Power Systems Revenues Look To Grow In 2022

October 24, 2022 Timothy Prickett Morgan

It was a pretty good third quarter for Big Blue on many fronts if you overlook a $5.76 billion writedown as it has transferred some of its pension obligations for retired employees to a third party to get them off its books forever. This is the second straight quarter that, ignoring this massive hit to the books, which was actually offset by some tax benefits IBM cashed in at the same time, the company has shown both revenue and profit growth.

This may not be the IBM of our salad days, but it is a far cry better from the steadily shrinking IBM we have watched pare itself down by selling off businesses and suffer from “secular declines,” as Wall Street calls them, in its core remaining businesses.

In the period ending in September, IBM’s revenues were $14.11 billion, up 6.5 percent as reported and gross profits were up 4.6 percent to $7.43 billion, giving the company a 52.7 percent gross margin – about two points shy of the average it has held over the past couple of years. After the $5.76 billion charge, IBM booked a pre-tax loss of $4.5 billion, and a $1.29 billion benefit from income taxes it has kept in its back pocket just for days like this (as companies often do) reduced its net loss to $3.21 billion. That is still a big hit, mind you, but it is more a reflection of obligations from the past projected into the future than it is a reflection of the underlying business. To another way of looking at it – the way we do, in fact – these kinds of “gotchas” are always part of the business and you can’t really make an exception for them. Accountants and federal regulators don’t, and the money is actually gone.

IBM ended the quarter with $7.82 million in cash and equivalents and $1.75 billion in marketable securities, which is enough to be safe if the economy should get truly rocky, but it is still sitting on $5.94 billion in short-term and $44.94 billion in long-term debt. A lot of that long-term debt is to cover the equipment in its partner channel and its lease portfolio, but it is still a lot of debt. If you take all of IBM’s assets and all of its liabilities, it is ahead with $20.1 billion in equity, more or less where it usually is on its balance sheet.

Big Blue reports its growth rates at constant currency, and we build a model that tries to figure out where its different divisions and product segments are and what their actual growth rates are, and here is what it looks like across the product families:

As you can see, there is definitely a fairly regular rhythm to the remaining IBM businesses, and you can definitely see the buoyant effect that the addition of Red Hat has had to the IBM software business, now mashed up under the Hybrid Platforms & Solutions label. IBM’s systems hardware business, including System z mainframes, Power Systems servers, and storage, is as choppy as ever. But also fairly steady.

Drilling down into that infrastructure business that is the foundation of IBM, and that always has been, what IBM calls Hybrid Infrastructure (servers and storage and their base operating systems) had $1.89 billion in sales, up 30.1 percent in Q3 according to our model, while infrastructure support for this gear was down four-tenths of a point to $1.46 billion. Add it up, and the Infrastructure group had $3.35 billion in sales, up 14.8 percent, with gross profits of $1.7 billion, up 10.5 percent. Pre-tax income, however, was flat at $280 million and down by a factor of 2.7X compared to Q2 2022. It is not clear what the problem is here, but we suspect some costs for ramping the Power10 entry and midrange machines are in here and possibly Power11 development costs, too.

What we always want to know is how the Power Systems business did, and IBM no longer lets us easily figure that out. Actually, it never easily did this but it was possible to do something because we had growth rates for Power Systems at constant currency. Now, IBM is lumping Power Systems and storage together as a single product division called Hybrid Infrastructure (which we think is a nonsensical name but that is another issue) and giving a constant currency growth rate for that. We made some assumptions about what this might mean for Power Systems, what is happening with currency rates and sales in different regions, and brought our Power Systems model forward from Q3 2021 when IBM last gave out the old statistics upon which our model was based. We realize the thin ice we are on here, but there is no other way to try to reckon this.

Given all of this, we think that Power Systems sales were up 13 percent to $216 million in the third quarter of 2022, and that related storage arrays based on Power Systems machines gave the Power Systems division another $52 million in revenues, up 15.6 percent. (The resulting DS series arrays generated a lot more revenue than that, of course.) That puts Power Systems revenues overall at $268 million, up 13.5 percent.

It is no secret that the Power Systems business is a lot smaller than it was, but in the past three years or so, as IBM has focused on its 160,000 or so IBM i, AIX, and Linux customers who buy Power-based machinery to run their mission critical workloads (and stopped chasing big supercomputer deals that actually lost Big Blue money), the revenue has come down only a bit and has stabilized.

We did a forecast going out one quarter and then summed everything up annually to give you a forecast, which is, all things considered, pretty good:

The forecast for is shown in the light blue bar, and we think there is a good chance, given the launch of the entry and midrange Power10 machines and the steady ramp of the high-end Power10 machines from this time last year, that overall Power Systems sales, including for plain vanilla servers and for machines sold to the Storage division for controllers in DS arrays, will rise by 11.5 percent to $1.48 billion.

This is a third of the rate of sales that IBM used to enjoy with the AS/400 alone in the 1990s and a third of the rate of the combined AS/400 and RS/6000 business during the Great Recession 13 years ago. And that sucks. But that sucks a whole lot less than the zero business there is for Sun Microsystems Sparcs or Hewlett Packard Itaniums or any number of Unix and proprietary machines that have joined the history books.

IBM’s Software group had $5.81 billion in sales, up 4.2 percent, with $4.2 billion of that coming from the Hybrid Platforms & Solutions division, down 1.1 percent, and $1.61 billion of that coming from transaction processing systems, up 21 percent. If you take Red Hat out of Hybrid Platforms & Solutions, then it was probably around $2.7 billion in sales and down 7.1 percent, as best as we can figure. Red Hat revenues were up 12 percent to $1.5 billion, as reported.

As you know, we try to reckon what IBM’s “real” systems business is every quarter and then we also like to plot Red Hat sales against this so you can see the uplift effect that Red Hat is having on that real systems business. Within this real systems metric, we add servers, storage, operating systems, middleware without databases, technical support, and financing all lumped together. This number has a lot of witchcraft in it, which seems appropriate at least for this time of the year.

Here’s the net-net. If you take the Red Hat revenues out of the real systems revenues, that IBM systems business is still in the slow, steady decline that it has been experiencing for decades. Power-based supercomputing sales helped bend the curve up a bit in 2017 and 2018, as did an especially good mainframe cycle. And now you can see why IBM was willing to pay $34 billion for Red Hat. It has another story to tell in systems. We still think IBM could create a better Linux box on Power than it has done with LinuxONE on System z16 mainframes, but IBM clearly does not believe that and has not done that.

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