Power Systems Slump Is Not As Bad As It Looks

July 27, 2020 Timothy Prickett Morgan

Even for companies selling hand sanitizer, face masks, toilet paper, and shotguns, it is still a weird time to be in business just like it is for the rest of us. The Cognitive Systems division within IBM’s Systems group – what most people still call the Power Systems division – is no different.

Big Blue is certainly facing some strong headwinds as it has to get through more than another year before the Power10 rollout begins, and the Power9 machines have really been in the field two and a half years already if you count the launch of the Power AC922 supercomputer nodes in December 2017. But there are some reasons for optimism, even in the short term.

For one thing, the System z15 mainframe cycle is pretty strong and it is carrying Systems group pretty nicely. (I sure do wish they would have still formally call it Systems Group.) Arvind Krishna, IBM’s new chief executive officer and the mastermind of the Red Hat acquisition, had nothing at all to say about Power Systems on the call with Wall Street analysts last week going over the financial results for the second quarter of 2020, but I will say this: Unlike a lot of other IBM CEOs for the past couple of decades, Krishna shows up and answers questions. Jim Kavanaugh, IBM’s chief financial officer, did mention in his prepared remarks that the weaker performance in Power Systems was reflective of where IBM is at in its Power9 product cycle and the fact that a lot of the client based is comprised of smaller enterprises that were impacted more during the pandemic.

As for System z mainframes, the z15 cycle started at the end of September last year and there is a relatively easy compare there as well as a fairly easy on with Power Systems, too. IBM says that System z mainframe hardware sales rose by 68 percent at constant currency (meaning not precisely as reported in US dollars, but gauged as an aggregate growth rate in local currencies). The actual growth rate is surely smaller. For Power Systems, the decline was tough, down 28 percent at constant currency. Thanks to the relatively high attachment rate of DS8900-class SAN storage with new or upgraded z15 mainframes, despite declines in other storage product lines, IBM was able to eke out a 3 percent growth rate for storage.

IBM reported overall System revenue external to Big Blue (meaning directly to customers and to its reseller partners) came to $1.85 billion, down 5.7 percent. IBM had another $240 million in sales of Systems products – meaning hardware and operating systems – an increase of 40.4 percent from the year-ago period. IBM also added that the System group had $248 million in pre-tax income, quadruple what it did a year ago as it was investing heavily in z15 and Power10 development.

The Power Systems business has its ups and downs, at both constant currency and what we reckon the growth is actually. This is definitely not a growth phase for external sales of gear, which is what IBM talks about mostly but which only tells part of the story.

We think there is a lot of upgrading that IBM is doing within its outsourcing base for both System z and Power Systems iron at Global Technology Services as well as a healthy uptick in sales of DS8900 SAN storage and some ESS parallel file system storage, both of which run on Power9 servers these days and both of which generate revenues for the Cognitive Systems group that do get broken out in IBM’s quarterly financial presentations. IBM does give sales for systems hardware and operating systems, which are the as-reported numbers and with constant currency growth, and in this case systems brought in $1.5 billion, up 13 percent at constant currency, and operating systems accounted for $0.4 billion, off 13 percent. The significant digits are too small here, and we want reported growth rates, not constant currency. This is the money IBM actually gets to spend, after all.

So every quarter, we run IBM’s numbers through our model. We think IBM actually had just a tad under $1.5 billion in systems sales, up 10.5 percent, and operating systems were $355 million, down 10.7 percent. The operating system software is very profitable, the hardware much less so but the mix is still pretty attractive. And hence IBM still continues to invest in systems. This is not as well as IBM did in Q4 2019, when it had $3.24 billion in total sales (external and internal) for Systems group with $802 million in pre-tax income, but also not as poorly as Q1 2020, when everything slowed down because of the coronavirus pandemic. In the prior quarter of 2020, IBM had a mere $1.52 billion in sales and reported a $217 million pre-tax loss. The financials in Q1 2019 were about the same, consistent with IBM’s historical patterns.

This chart shows sales of Power Systems external to IBM to resellers and directly to customers as well as what we reckon the Cognitive Systems division that controls the Power platform sold to the Storage division. These figures do not include hardware sold to Global Technology Services or other IBM groups or divisions or operating system sales related to Power iron.

When we run things through our model, we think IBM had $365 million in external Power Systems sales to resellers and customers, down 29.5 percent for realsies, not at constant currency, and we think that Power-based storage sales rose by 60 percent thanks to the z15 bump to $77 million. So that core Power Systems hardware business came to $442 million, down 21.9 percent. So it is not as bad as it looks the way IBM does its financial reporting. It is hard to say how much the operating systems and Global technology Services sales of iron and systems software add to this, but we think that the addition of these two revenue streams would boost overall sales to between $550 million and $600 million. To be precise, our model says there was $51 million in sales of Power-based hardware to Global Technology Services, and then another $82 million from operating systems.

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