Merrill Lynch Takes a Closer Look at IBM's Server Sales in Q1

Published: April 24, 2007

by Timothy Prickett Morgan

When it comes to server sales, the first quarter is never a particularly fun one for IBM. For IBM's historical and IT budgetary reasons--it is hard to say which one is the chicken and which one is the egg in that situation--companies with enterprise systems have tended to do a lot of their shopping in the latter half of a year, particularly as the year is ending and budget funds will evaporate if they are not spent. Similarly, having shot their budgets in Q4, they are not in a position to consume more gear in Q1, so they tend not to.

This is exactly what happened in the first quarter of 2007 for Big Blue. While IBM talks about year-to-year percent changes as it talks about its four server lines during each quarter's financial results, it doesn't talk specific sales levels for each of the products. But, luckily, there is usually a brokerage house on Wall Street that does the estimates, and these days, Merrill Lynch is the one that takes a stand and models IBM's revenue streams.

Richard Farmer, the IT analyst at Merrill Lynch, put out a report the day after IBM's numbers ran last week showing where he thought the numbers were for the quarter ended March 31. System z sales, including new servers and upgrades, accounted for $618 million in sales, up 12 percent. System i sales were down 13 percent in the quarter, to $205 million, while System p sales rose by 14 percent to $829 million. The important thing to note here is that you have to look at the entire Power-based server line and not get hung up on operating systems and system labels (at least if you want to think like IBM, not a proponent of the i5/OS or AIX platform). In the first quarter of 2006, which was not a very good one for either the System i or System p lines because of the impending Power5+ announcements, total Power-based server sales, based on Merrill Lynch's estimates, came to $967 million, while in the same quarter in 2007, sales were $1.03 billion, which is an increase in 6 percent for the Power platform. System x sales were just over $1 billion in the quarter, up 7 percent on declining server volumes, but still better than any other product in terms of aggregate revenues.

Because brokerage houses are interested in making predictions about company performance so they can recommend a stock as a buy, sell, or hold, they often make forward and specific predictions--something that companies themselves rarely do. Merrill Lynch is projecting that mainframe sales will slow in the next few months and actually decline sharply in the third quarter and rebound a bit in the fourth quarter, resulting in essentially flat sales at $3.7 billion. The brokerage house is projecting that System i sales will decline in all four quarters of 2007, but not to the extent as they did in the first quarter; Merrill Lynch expects System i sales to be down 5.3 percent for the year, to $1.2 billion in sales. The System p boxes will, in the brokerage house's models at least, do better, with $4.09 billion in sales in the year (up 7.6 percent in a declining Unix market). But in the middle of the year, the System p line is expected to see declining growth rates for sales as 2007 progresses, thanks to competition and the shift to Power6 machines.

Here's the important bit to remember: In all of 2007, if Merrill Lynch's numbers turn out to be accurate, IBM will book $5.3 billion in Power-based server sales, up 4.4 percent and outpacing the likely revenue growth of the server market as a whole. As I have said a lot of times before, IBM just wants to sell Power servers. It doesn't much care which ones so long as there are growing revenues and profits. The System p is the revenue engine, and the System i is the profit engine, and apparently IBM has made cost cuts somewhere, according to Mark Loughridge, the company's chief financial officer, in the System i line. (Loughridge also said that IBM was able to sell capacity on demand upgrades, boosting margins even as revenues fell.) As for the decline in System i sales, no CFO that I can remember has ever said that he was committed to stemming the revenue declines. "This is not a new phenomenon for us to deal with," was all that Loughridge said in a call with Wall Street analysts.

Indeed.

The X64-based System x business will be smaller than the Power server lines combined for 2007, if Merrill Lynch turns out to be right, with $4.5 billion in sales, up 6.8 percent.

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Slowing U.S. Sales Hurt IBM's First Quarter

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