At The End Of The Power8 Long Tail

July 25, 2016 Timothy Prickett Morgan

Largely for economic reasons relating to IBM‘s high costs in chip manufacturing and relatively low chip volumes, the Power Systems platform left the familiar cadence of Moore’s Law progress quite a while ago. IBM stretched it out to three years or more between processor cycles, and here we are in the middle of 2016 and we are still probably at least a year away from the Power9 launch. At the tail end of any product cycle revenues are bound to dip, and this is precisely what is happening to segments of the Power Systems line.

The bad news for IBM is that its System z mainframes are also on the last third of their long tail, and that means its system business as a whole is on the downswing.

This drop in Power Systems revenues comes after Big Blue was able to turn in four quarters of revenue growth in 2015, at least when sales were measured in the local currencies where the machinery ended up being installed. It would be better, of course, if actual revenues were up, and by double-digit percentages, to demonstrate the perspicacity of the Power Systems line. But even in the decline that IBM turned in during the second quarter of 2016 for the Power Systems division, there is some good news.

“Power revenue was down in the second quarter, with growth in the midrange offset by declines in the high and the low end,” explained Martin Schroeter, chief financial officer at IBM, in a conference call going over the numbers with Wall Street analysts. “The Unix market is a high-value space that has been declining, and we represent the majority of the market. Our performance here reflects the replacement dynamic, following strong performance in the high end of Power8 in the second quarter of last year. While the midrange has been growing year-to-year, we will see a similar replacement dynamic in the third quarter, as we wrap on the midrange Power8 introduction.”

IBM does not report actual revenue figures for the Power Systems line, but Schroeter did say that Power Systems revenues were off 24 percent compared to the second quarter of 2015, with System z mainframe revenues off a much more steep 40 percent and storage hardware down a less harsh 13 percent. Our guess is that the revenue streams for these three different parts of the IBM Systems hardware business, which brought in just a hair under $1.5 billion with an overall decline of 28 percent, were about evenly split, and operating systems pushed the overall spending to $1.95 billion. Our precise estimates are that IBM sold $1.49 billion in hardware and $465 million in operating systems, with the latter only declining 4 percent thanks to the monthly rental of software for System z machines, which tends to be steady and which represents the bulk of IBM’s operating system revenues. IBM sold another $206 million in hardware to other units within Big Blue (up 9 percent), and gross profits came in at $1.1 billion (down 23.2 percent) with pretax income of $229 million (down 57.4 percent). Those profit hits come from the lower sales level, and we think, from the investments that IBM is making in the future Power9 chips coming next year.

IBM has been very aggressively pushing its Linux-on-Power strategy, and Schroeter revealed that in the second quarter ended in June, Linux machines represented 10 percent of the overall Power Systems revenues. That is up from a few percentage points two years ago when IBM started the OpenPower Foundation to help spread Power technology around the IT ecosystem, and it obviously does not include any revenues that OpenPower partners are getting as they sell their own Power8 wares. We think that, going forward, it is incumbent on IBM to provide sales figures across the OpenPower ecosystem to show its growth–something that ARM Holdings, which has also put together a collective to attack the datacenter, has stubbornly refused to do for the nascent ARM server chip and system business. At some point, IBM’s Power Systems business could conceivably be only a portion of the overall OpenPower revenue stream, but unless IBM brags about it each quarter, we won’t know.

There is a lot more to IBM’s core systems business than the hardware in the Systems group or the operating systems revenues that are tied to its iron (including AIX and IBM i and their toolchains and even the resale of Linux from Red Hat, SUSE Linux, and Canonical). IBM sells various transaction processing software for mainframes and other systems as well as integration software that bears the WebSphere and other brands, and technical support services. If you allocate a chunk of these revenue streams to the actual systems business at IBM, you have a much better view of what is actually going on, and we have done that in the chart above.

As you can see, IBM’s overall revenues and its systems businesses have been trending downward over the past several years–longer than even this data shows, which is based on its most recent classification of its operating groups and divisions that it rolled out at the end of 2015. If you add it all up, the core systems business at Big Blue accounted for around $6.45 billion in revenues in the second quarter, down 12.6 percent. If you look at the trailing 12 months, IBM’s core systems business brought in $26.75 billion, off 12.7 percent. Perhaps more significantly, if you look at the 36-month Moore’s Law cycle IBM has for systems and estimate similar declines for Q3 and Q4 of this year, then over the past three years IBM will have raked in something like $86 billion in revenues from systems with an aggregate gross profit probably somewhere in the range of 55 percent, perhaps even higher.

This is not a bad business, and in fact, it is a good business. It is just that IBM talks stupidly about it because it doesn’t want to admit to Wall Street that it is, at its core, a systems company. This is apparently not cool enough, but if you chop it all up and chant “mobile, social, cognitive, cloud” enough times, apparently it is.

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