Power Systems Sales Hammered Down In Q3

October 21, 2013 Timothy Prickett Morgan

What happens–or doesn’t happen–in China has a much larger effect on IBM i shops in the rest of the world than perhaps any of us might have anticipated. The return to profitability for IBM‘s Systems and Technology Group in the second quarter was short-lived and the group was pushed into a loss in the third quarter by a freeze on spending in China. Economic growth in the Middle Kingdom is the weakest it has been since 2000, and the government of President Xi Jinping has been working since May to put together reforms and a stimulus package. Those reforms are not completed yet, and thus spending by state-owned companies has been curtailed.

This slowdown is the cause of Big Blue’s latest woes in its systems business, and the Power Systems business was hit particularly hard.

In a conference call last week to discuss IBM’s third quarter financial results, Mark Loughridge, the company’s chief financial officer, said that Big Blue did not expect for the Chinese government to finish its planning until the middle of November and that it would take at least two quarters for spending to pick up again. And given that the word on the street is that China is going to focus more on economic reforms than on stimulus spending, it would be wise to not count on a big flood of money coming into state-owned businesses and therefore a big bump in IT spending.

Here’s how bad it is. In last year’s third quarter, IBM’s revenue growth in China was up 19 percent, and it grew enough to account for about 5 percent of IBM’s overall sales. Hardware sales accounted for about 40 percent of overall sales in China for IBM, which is a factor of 2.5 times higher on the hardware spending than IBM at large. It is a bit like the dot-com boom in China right now. Or rather, it was. In the current third quarter, sales in China were down by 22 percent, and hardware sales in the country were down a staggering 40 percent. After the new economic plan comes out from the Xi government, IBM is only expecting for growth in China to be in the mid-single digits, according to Loughridge.

In other words, the party is over, and the Chinese government is taking back the punch bowl. It will be interesting to see–or if it will be possible to see–if there will be pressure on local IT suppliers such as Lenovo and Inspur to get a larger slice of systems sales in China. Thus far, IBM and Dell have been able to walk a tightrope with the Chinese government by shifting some design and a lot of production of their machines to China in exchange for being able to more easily sell their gear there. China gets the jobs, the IT vendors get the relatively cheap labor and to be working in an ecosystem of ODMs and parts suppliers who are also located in China.

In the third quarter, the Power Systems business was down 38 percent against a fairly strong quarter in the year-ago period when sales were only down 2 percent. Part of the problem is that IBM is not selling as many Power-based supercomputers as it once was, and Loughridge in fact said that of that 37 point decline for Power Systems, 10 points of it was due to a drop in Power-based HPC system sales.

What happens way up there in the supercomputing stratosphere affects the rest of the Power Systems line down in the midrange. Huge sums of money dedicated to research and development for HPC systems lay the groundwork for technologies that make their way into commercial systems years hence.

IBM walked away from the “Blue Waters” Power 775 system at the University of Illinois after receiving $297 million from the U.S. Defense Advanced Projects Research Agency to develop this huge machine and its PERCS programming environment. Even after that massive infusion of R&D from DARPA, IBM contended that it would be too expensive to build a multi-petaflops system for the National Center For Supercomputing Applications at the university, and Cray waltzed in an was able to sell a hybrid XE6-XK7 system to NCSA, which sported some GPU coprocessors alongside the Opteron chips, for $188 million. At list price, a Power 775 system with a petaflops of floating point performance would have cost something on the order of $150 million and would have sported 524,288 Power7 cores. I estimated at the time when the deal was killed in August 2011 that it might take twice as much iron to get sustained petaflops performance, and then NCSA would be in for a $300 million sticker shock. IBM said at the time that the Power 775 implementation of Blue Waters was just too expensive to manufacture and make a profit.

Similarly, while IBM has been able to push its BlueGene/Q massively parallel system up to 100 petaflops, the largest system installed to date is the “Sequoia” machine at Lawrence Livermore National Labs, which has 96 cabinets and over 20 petaflops of peak performance. This machine is wickedly efficient in terms of computational and energy efficiency, but IBM has stopped talking about BlueGene and as far as anyone knows, the company is not making more investments in it. If I had to guess, I would say that the future of Power-based supercomputing will be hybrid machines consisting of Power8 processors and Nvidia Tesla GPU coprocessors tucked into those NextScale hyperscale boxes announced earlier this summer. IBM could use the Power 775 interconnect to link machines together, or just go with InfiniBand.

I think IBM can make a credible case for Power8 plus GPU accelerators in cheaper iron, all running Linux, and get HPC sales for Power Systems back on track. But that probably won’t happen until the second half of 2014, if it happens at all.

The real issue for Cray, IBM, and Silicon Graphics is that DARPA is no longer funding primary research into large-scale systems, and that, in the long run, will affect the kinds of machines that will be in data centers in the future. I know this is not a normal discussion about IBM’s quarterly figures. But this is important stuff, particularly as IBM has lost the game console chip business that used to help prop up the Power chip business to Advanced Micro Devices, which had design wins with Microsoft and Sony for the consoles that will ship in the holiday season. My point is that there is a lot of pressure on the Power Systems business to rebound at a time when it is being hit from a number of different angles, and the downturn in China is just one of them.

In the quarter, IBM’s System z mainframe business had a 6 percent revenue jump, and Loughridge said that sales of the zEnterprise EC12 and BC12 machines would “wrap around” from whole machine sales to “microcode upgrades” next year. (He means companies with existing boxes would be using capacity on demand to activate cores next year after having bought new machines last year and this year.) The effect of this shift is that IBM’s mainframe revenues go down, but the business is more profitable because activating a core on a mainframe costs basically nothing while building a machine costs a whole lot. MIPS shipments in the quarter were up 56 percent, and MIPS capacity shipped on specialty engines for accelerating DB2, Java, or XML or running Linux. IBM launched the Power Integrated Facility for Linux two weeks ago precisely to get a similar revenue boost as it chases large Linux shops.

IBM’s System x business was off 16 percent, and storage hardware sales for flash, disk, and tape products were down a collective 10 percent. Oddly enough, in the major markets (North America, Australia and New Zealand, and Western Europe), storage revenues were up. The Storwize line that is at the heart of the PureSystems converged systems line had double-digit revenue growth, but high-end and midrange products slumped, according to Loughridge.

Add it all up, Systems and Technology Group had a 16.6 percent revenue decline overall, with sales of $3.25 billion and a pre-tax loss of $167 million. IBM hopes that it can get revenues back on track once the Power8 chips are shipping in systems in the second half of next year.

IBM said that revenues in Software Group were a little lighter than anticipated, at $5.8 billion, up only 1 percent, but even still this part of Big Blue brought in $2.41 billion in pre-tax gains. The Global Services group had a $141 billion backlog of orders as the third quarter came to an end, posted $14 billion in sales, and had a pre-tax income of $2.82 billion. Profits for IBM’s services businesses were way up thanks to layoffs executed earlier this year, but revenues were still off nearly 3 percent.