Power Systems Hit By The Pandemic In Q1 2020

April 27, 2020 Timothy Prickett Morgan

Thirteen weeks ago, when IBM reported its financial results for the fourth quarter of 2019, we told you that the Power9 platform was entering the long tail, that part of the cycle of the this generation of Power Systems machines where the revenue would dwindle off between that time and when the Power10 servers launch sometime in 2021. That tail perhaps just got a little longer and skinnier thanks to the coronavirus pandemic.

IBM doesn’t talk very much about the specifics of revenues and profits for the Power Systems line any more, just like it stopped talking about the iSeries and System i platform uniquely in its financial reports many, many years ago and just lumped it all into Power Systems. But as we all know, while the AIX base drives a lot of the revenues thanks to relatively large NUMA machines, the installed base is dominated by the IBM i platform, and many of them are small and medium businesses – those most adversely affected by the economic stall caused by the stay at home provisions of trying to flatten the sickness and death curves of the coronavirus outbreak and its COVID-19 disease.

Here is all that Jim Kavanaugh, IBM’s chief financial officer, had to say about the Power Systems line in his remarks on the conference call with Wall Street: “The growth in System z and storage was partly offset by a decline in Power. This reflects where we are in our product cycle, as well as the fact that Power is more skewed to smaller enterprises, which were more impacted by the dynamics in March.” Kavanaugh added that IBM was expanding its digital sales channel for both the Power Systems division and the Storage division within the Systems Group, which is still managed by Tom Rosamilia, now under new chief executive officer Arvind Krishna, who took the helm earlier in April after this quarter closed, and president Jim Whitehurst, formerly chief executive officer at Red Hat, now part of IBM.

For the past several years, in the absence of hard data from IBM, we have put together a model of Power Systems server sales as well as revenues derived by the Power Systems division as a share of the Storage division’s sales of high-end DS series disk arrays, which are based on Power iron. The new DS-8900 arrays are based on Power9 servers, for instance, and are being attached to deals for new System z15 machines, which saw sales rise by 61 percent at constant currency in the quarter. Power Systems saw a 32 percent decline in the period at constant currency, and we reckon it actually fell by 33.5 percent as reported, to $181 million, and that Power-based storage arrays actually rose by 40 percent or so to around $41 million. Add it up, and the Power Systems revenue stream in the first quarter of 2020 was off 26.4 percent to $222 million.

There is no sugar coating this to get rid of the bad taste, so I will just say it. This was, as far as our model can tell, the worst quarter that IBM has turned in for Power Systems since the Great Recession – and by a long shot – and was even worse than the first quarter of 2017, which was the previous low for the hardware platform. And it is not at all surprising, and this does not mean IBM’s commitment to the Power processor and its servers is waning. It is just the double whammy of the COVID-19 crisis and the natural long tail of diminished sales as Big Blue and its customers both await the Power10 processors and their machines.

The question now is will the next two or three quarters, or next one or two years, be better or worse than this new low point? We honestly have no idea.

Here is what we do know. IBM’s overall sales were only off 3.4 percent to $17.57 billion, and even though it had a pre-tax loss of $49 million because of restructurings in its Global Services group and some writeoffs related to the Red Hat acquisition, IBM had a tax benefit that allowed it to put up a $1.18 billion net income. The company had already suspending share buybacks ahead of the Red Hat deal closing, and that means it is not wasting money trying to make Wall Street richer and maybe – just maybe – it is interested in investing that money instead in its future. This is IBM’s low point, we think, and both IBM and Power Systems can grow from here. It might take a year, or longer, thanks to COVID-19. But the Systems Group had hardware sales of just over $1 billion plus operating system sales of $367 million, and including another $148 million in sales to other divisions, Systems Group had sales of $1.52 billion, up 1.7 percent. The System z15 is shining and driving revenues and profits at the time when Power Systems won’t. And in 2021, when the System z15 mainframe is entering its long tail, the Power10 will be starting to ramp and will carry IBM’s systems business into 2022. We are a bit concerned that the Systems Group had a pre-tax loss of $217 million in the first quarter, even as mainframe sales and storage sales were on the rise. There was no explanation of this, but it could have to do with Power10 development costs and foundry costs with partner Samsung, which will be etching the Power10 chips for Big Blue in its 7 nanometer fabs.

As far as we can tell, the core systems business at IBM still generated around $5.7 billion in business in the first quarter of 2020, down 3.7 percent, with gross profits of around $2 billion, down 22 percent. This is just for servers, storage, operating systems, transaction processing middleware, integration software, and financing as it applies directly to sales of System z and Power Systems machinery – not to any of these wares and services applying to other non-IBM platforms.

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