Power10 Keeps Plugging Along As Power11 Looms For 2025

November 4, 2024 Timothy Prickett Morgan

Considering how late we are in the Power10 and System z16 product cycles, things went pretty well for IBM in the respective Power Systems and System z businesses in the third quarter of 2024. While customers always look forward to future price/performance enhancements that come with a product refresh, there doesn’t seem to be anything out of the ordinary when it comes to a slowdown in sales ahead of next year’s Power11 and “Telum-II” System z17 launches.

Business seems to be going pretty well for Big Blue, all things considered, although it had to pump $2.73 billion into its pension program to cover incremental costs in its ancient defined benefits pension plans that are still in effect for IBMers who retired a decade or two ago from the company. These charges are not as large as they have been historically, and for morbid reasons if you think about it for a second, but IBM will probably be hit by “pension surprises” for at least another decade, however diminishing they will be over time.

But the situation is weirder than it sounds. IBM stopped giving new employees a pension in 2005, switching everyone to 401(k) programs with some employer matching. IBM had a surplus of $5 billion in the pension plan as 2024 started, and reopened the defined benefit plan to employees so it could use this surplus to fund the matching rather than cash on hand, as was explained in this detailed story from the Center for Retirement Research at Boston College back in February. So, given all of this, it is a bit of a mystery as to what this $2.73 billion pension charge is, but there it is on the books, pushing IBM to a loss for the quarter.

We didn’t want to focus too much on this, but any loss by IBM requires explanation. There were other factors at work in Q3 2024. Depreciation and amortization was up by 16 percent to $1.27 billion, stock-based compensation was up by 15.4 percent to $330 million, sales and general expenses were up 10.2 percent to $4.91 billion, and research and development costs were up by 11.3 percent to $1.88 billion. That is an incremental cost of $863 million in just running the company and preparing for 2025, with the $2.73 billion hit on top of that. So given all of this, perhaps it is remarkable that IBM only posted a net loss of $330 million against $14.97 billion in sales, compared to a net gain of $1.7 billion out of $14.75 billion in sales in the year ago quarter.

By the way, gross profits were 56.3 percent of revenue, and were a little bit higher than average and up 5 percent against a 1.5 percent revenue growth. So the underlying business is getting healthier by some measures.

In the quarter, as the Power10 and z16 lines continue to wind down, revenues for the Infrastructure group that sells servers, storage, systems software, and maintenance services for IBM’s two core platforms, was down by 7 percent to $3.04 billion, but gross profits were only off 4.4 percent to $1.67 billion, representing 55 percent of revenues. This is an average level for gross profits on IBM hardware.

That gross profits did not decline as fast as revenues due to the fact that a lot of the revenue is coming from compute and memory capacity upgrades done on demand at the end of the Power10 and z16 product cycles – and indeed even on some Power8 and Power9 and z14 and z15 systems. These capacity activations are a lot more profitable than building and shipping the initial machine three or four years ago with most of its capacity in latent, inactivated form.

Within that Infrastructure group, we think that server and storage sales accounted for $1.72 billion in revenues, off 9.9 percent, and infrastructure support brought in $1.32 billion, down 3.1 percent year on year.

As capacity increases on machines, so does middleware and database software revenues, and in Q3, the Software group saw revenues rise by 4.1 percent to $6.52 billion, and gross profits rose by a much faster 9 percent to $5.43 billion, representing a typical 83.2 percent of revenues.

When we look at IBM through the eyes of The Four Hundred, we always want to get a sense of how the Power Systems business is doing, and because Big Blue doesn’t carve this business out separately, we have to infer it from past results, change over time, and vague statements IBM makes. This is made more complex because its “Distributed Infrastructure” division consists of Power Systems and all storage mashed up together.

Distributed infrastructure sales were up 3 percent as reported, and we think storage did a little bit better than that average and Power Systems did a little bit worse. When we do the math in our model, overall Power Systems revenues grew by 2.5 percent to $230 million, and Power storage revenues – meaning Power servers sold to the Storage division to make the DS and ESS disk arrays as well as Fusion hyperconverged storage clusters – were up by 21 percent to $47 million. IBM loads these storage servers up with its software and loads them up with flash and sometimes disk and sells them for a boatload of money.

Add it all up and we think Power Systems revenues, including revenue streams from PowerVS instances on the IBM Cloud, were $277 million, down less than a point year on year from the $280 million we reckoned IBM brought in for sales of Power-based iron in Q3 2023. System z revenues were off 19 percent; we do not have a model to estimate revenues for this hardware, or for storage, but we should do that. It is difficult without some datapoints to check against, which we have with Power Systems. (Ahem.)

We think Power Systems will show growth for 2024, despite it all, but we shall see.

IBM’s “real” systems business is much bigger than the Infrastructure group, of course. Once you start adding middleware like transaction processing and other application serving middleware that is inherent to the systems to the mix, and then toss in financing for the stacks, you soon find out just how massive the system business at Big Blue is. And that is without throwing in database and application software that IBM sells for billions of dollars per quarter in either rentals or licenses.

When you add all of that up, putting the appropriate Red Hat systems software into the mix – Red Hat Enterprise Linux, OpenShift, and OpenStack, which are in its Hybrid Platforms division inside of Software group – into the bucket, then IBM’s real systems business came in at about $6.16 billion in sales in the third quarter ended in September, up six-tenths of a point and we estimate pre-tax income was up 1.6 percent to $3.2 billion, which is 51.9 percent of revenues. That Db2 database software that runs across IBM platforms is where the profits come from, as you can surmise.

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