The IBM Profit Engine Keeps A-Rolling in Q4

January 25, 2010 Timothy Prickett Morgan

IBM may no longer be the top provider of IT products and services in terms of annual revenues, but it is by far more profitable than its larger rival, Hewlett-Packard, which became king of the IT hill last year with $114.6 billion in sales (in fiscal 2009 ended in October) but which, at $7.7 billion in net income, only brings a little more than half of what IBM does to the bottom line. In IBM’s full 2009 year, the company had sales of $95.8 billion, down 7.6 percent, but net income was up 8.8 percent to $13.4 billion.

In discussing IBM’s results with Wall Street analysts after the market closed last Tuesday, Mark Loughridge, the company’s chief financial officer, said that IBM has been able to grow its profits so much in the past decade by shifting to higher-margin software and services products, ditching low-margin products that were commoditizing, and investing in new areas and making acquisitions to chase new opportunities. Loughridge did not mention that Big Blue also gets profits by chopping jobs in the United States, Canada, and Europe as it adds jobs in China, India, Russia, Singapore, and other lower-cost labor markets. It is politically uncool to mention this, of course, but it is nonetheless true. IBM is not the only manufacturer and software developer that has offshored jobs–all IT suppliers have done it, as globalization and the need to show ever-larger profits insist they must.

In the fourth quarter, IBM posted overall sales of $27.2 billion, rising eight-tenths of a percent as reported thanks to the strengthening dollar, but down 5 percent at constant currency (which means measuring sales in the geographies and currencies where the deals get done before they are converted to dollars and brought back to the books at IBM HQ in Armonk, New York). IBM had a similar 5 percent constant currency revenue decline in the third quarter, and while the company is brilliant at engineering profits, it has not yet engineered real revenue growth as gauged in constant currency. While the economy was improving in the second half of 2009–so we hear from the economists, at any rate–revenue growth at constant currency at IBM did not happen. But looking ahead to the first quarter of 2010, Loughridge said he expected real and constant currency revenues to improve by between 4 and 5 percent compared to Q4 2009, which means Big Blue is getting closer. Software Group, which is expected to post double-digit revenue gains in the first quarter (thanks in part to a number of large deals slipping from 2009 into 2010), is going to be a big help in this regard.

IBM is a platform company, first and foremost, and no amount of nattering about services changes that. The Systems and Technology Group, which makes servers, storage, systems software, and chips as well as technologies that it OEMs to other suppliers, hit $5.2 billion in sales in the fourth quarter, down 4.3 percent as reported and down 9 percent at constant currency. Clearly, servers are not yet out of the economic woods. But impending upgrades of the Power Systems and System z lineups in 2010 are also causing issues, since many customers want to push off upgrades and new system acquisitions until they see what the new iron looks like and how it is priced.

Loughridge said that System z sales were down 27 percent in the quarter, and that MIPS capacity shipped was down 19 percent. That means IBM is cutting the cost per MIPS to drive sales, as it has been doing formally since last fall with Solution Edition System z10 mainframe bundles and, no doubt, through discounts to mainframe shops who would prefer to wait for the z11 engines, perhaps due in the third quarter if the scuttlebutt is right. Loughridge said that mainframe sales were “consistent with what you would expect at this point in the product cycle” and added that the next-generation System z was coming “later this year” without being specific about when.

The 14 percent decline in Power Systems sales–what Loughridge still calls Converged System p for some silly reason–was also to be expected as the server market is still being hammered by the economic downturn, but everyone knew last quarter that Power7-based machines were coming sometime in the first half of 2010. As we report elsewhere, Loughridge said that Power7 machines would start rolling out in the first quarter of this year, and some customers probably knew that, too. Hence the downdraft in Power Systems revenues in Q4.

That said, Loughridge believes IBM gained 2 points of market share with Power Systems (he more than likely meant 2 points of share in the Unix racket), and added that in 2009 the company had over 500 competitive wins against Sun Microsystems and Hewlett-Packard, generating more than $600m in sales; thanks to slashed Power Systems memory prices announced at the end of November, IBM was able to do more nearly 200 competitive takeouts in the fourth quarter alone, and these deals generated nearly $200m in sales.

The big surprise this quarter was IBM’s System x and BladeCenter X64-based servers. IBM said that System x server revenues were up by a wickedly market stomping 37 percent in the fourth quarter of last year, and BladeCenter blades based on X64 chips saw an amazing 56 percent revenue bump. Of course, IBM’s System x/BladeCenter business fell by 32 percent in the year ago quarter, and I think that was because Big Blue’s large enterprise customers, who buy a lot of its servers in big lots, canceled X64 server orders when the economy went south and had to keep their mainframe, Unix, and i deals going forward. You can make do with existing front-end systems, but back-end systems that were in the process of being upgraded are a lot harder to put off. As good as Q4 was for System x and BladeCenters, as far as I can tell, 2006 and 2007 still had higher sales rates. So it will take 2010 to get back to 2007’s levels.

IBM’s storage business bumped along, growing 1 percent as reported but down 4 percent in local currencies. IBM’s midrange DS series of disk arrays and the XIV clustered file systems did well, driving disk array sales to 6 percent growth in the quarter–and that is real growth in constant currency. IBM added 130 XIV customers in the quarter, boosting its customer count to over 400 for these esoteric clustered disk arrays. Tape product sales (drives plus arrays and libraries) declined 10 percent, but there are no surprises there. While tape is still vital, there is intense competition and pressure to reduce costs.

IBM’s Software Group, which gets so much of its sales thanks to the vast installed base of mainframe, Power, and X64 platforms, had $6.6 billion in sales, up 2 percent as reported and down 4 percent at constant currency, and steady gross margins of 87.7 percent. About $1.25 billion of IBM’s software sales in the quarter came from middleware that runs on mainframe and midrange platforms that is not related to key brands (WebSphere, Information Management, Tivoli, Lotus, and Rational), and operating systems accounted for $592 million in sales. Those key branded middleware products mentioned above had an aggregate of $4.1 billion in sales, up 6 percent as reported and flat at constant currency. As you can see, the downdraft in servers affects those operating system and non-key middleware sales, which grew at a slower pace. WebSphere, with a 13 percent sales increase across all products, lead the pack, with IM and Tivoli seeing 7 percent growth, Lotus seeing a decline of 5 percent and Rational seeing a 4 percent decline.

What to say about Global Services? It’s big, it’s bad, and it’s a hell of a lot more profitable than a decade ago, and that says more about the complexity of IT systems than perhaps anything else I can think of. Global Services is the Antifourhundred. I could go on, but I won’t.

In the fourth quarter, Global Services had $14.6 billion in sales, up 2.1 percent but down 5 percent as reported. The company ended the quarter with a $137 billion services deal backlog, up $7 billion from a year ago. Outsourcing revenues declined by 2 percent at constant currency, and the nebulous Global Business Services unit had a 9 percent decline as companies cut back. Interestingly, outsourcing bookings were up 5 percent as reported to $8.6 billion in Q4, and IBM’s application outsourcing business was up like a firework to $2.8 billion, up 65 percent. Yes, I know, it is stupid to put application outsourcing in the Global Business Services unit instead of the Global Technology Services unit. But this helps make GBS look like it is doing better than it is.

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