IBM Goes All-In On Hybrid Cloud
October 12, 2020 Timothy Prickett Morgan
Well, that was a bit of a surprise, and probably something that only obliquely matters to IBM i shops at the moment, but Big Blue’s top brass has decided to carve out its managed infrastructure services business from Global Services and spin it out as a new, publicly traded company.
This business, which is tentatively being called NewCo until a real name is provided, is expected to be cut loose in a tax free manner and distributed to IBM’s shareholders by the end of 2021, so we have some time to assess the ramifications, if any, for the IBM i base. The core of the $19 billion NewCo is the outsourcing and hosting business that made Global Services gigantic and, in a very real sense that we have described many times, saved IBM because it gave the company a story to tell and then live up to in the very difficult 1990s.
Looking at the prior 12 months of sales, the NewCo business brought in about $19 billion in revenues, according to IBM, which hosted a briefing with Wall Street analysts on Thursday to go over the separation. The remaining IBM will be smaller, at $59 billion a year, but growth in its cloud sales, including Red Hat, will now seem that much larger against a smaller base. In the trailing 12 months, Red Hat revenues were up by 19 percent, from $3.5 billion to $4.2 billion, and that very good growth – smaller than many expected, mind you – gets lost in the noise of the much, much larger NewCo business that is pulling down.
IBM will pay pretty handsomely for spinning out this business, which will incur a $2.3 billion charge at the end of 2020 for “structural actions” plus another $200 million or so as the deal closes next year, including around $1.5 billion in cash charges and around $1 billion in balance sheet charges. Presumably the IBM stock split to form NewIBM and NewCo will be proportional to the revenue streams of the two pieces of Big Blue that remain.
There is a certain amount of Power Systems iron running within the piece of the current Global Technology Services business that forms the core of NewCo, and the customers who have IBM run their applications on outsourced iron (meaning IBM literally takes over your stuff and usually some of your people and moves them to its own datacenter) or hosted iron (meaning IBM owns the iron and runs your applications on it) do upgrade their machines every couple of years as workloads dictate. This is an important source of revenue for the Systems group, and the majority of internal sales for Systems group are for servers and storage sold to Global Technology Services for this purpose. According to our 2019 revenue model, we think Global Technology Services bought $250 million in Power machinery and the Storage division bought another $226 million of Power servers to underpin the DS series of SAN storage arrays, which are basically AIX servers running storage software. Customers outside of IBM, by contrast, bought $1.78 billion in Power Systems servers, so this internal Power sales number is not an insignificant one and one big piece of it will now come from NewCo and it will be booked as an external sale. It will be interesting to see if NewCo will stretch out the lifetimes of Power Systems and System z iron as real customers do. We suspect the Global Technology Services customers might have had shinier iron than customers buying their own gear.
The most important thing about this table above, which shows what is staying and what is going, is that IBM is keeping servers, storage, operating systems, middleware, databases, break/fix and other technical support services, and IBM Cloud, and it is also retaining the core IT consulting, systems integration, process services, and application management services that are part of the Global Business Services Edition, the latter of which has a $41.1 billion services backlog against something on the order of $23.8 billion in revenues. NewCo has a $60 billion backlog against a $19 billion revenue stream, so that ratio is higher. NewCo has 4,600 customers in 115 countries and around 90,000 employees will be leaving Big Blue to go to NewCo, leaving something on the order of 260,000 employees in what we will call Littler Blue to be funny.
So, why is IBM doing this? Aside from getting slowly declining businesses out of its revenue stream, it is also because IBM wants to focus entirely on hybrid cloud. That means enterprise customers who have on-premises, mission critical systems who want to extend out into one or more public clouds, or maybe even run solely across one or more public clouds.
Here is what IBM is really focused on: Making money from hybrid cloud. It’s no sexy, and some have argued that no one is going to get excited about “plumbing,” and they are right. But if IBM can make money with hybrid cloud, it doesn’t matter if it is more boring than being Amazon Web Services, Google, or Microsoft. The way that IBM sees it, for ever $1 that customers spend on core Red Hat infrastructure software for hybrid cloud – Enterprise Linux operating systems and OpenShift Kubernetes container controllers with perhaps some storage and virtualization – they spend another $1 to $2 for the physical infrastructure and another $3 to $5 for middleware and applications and another $6 to $8 for various kinds of cloud transformation services. IBM knows that others sell servers, storage, cloud infrastructure, applications, middleware, and cloud transformation services, so it cannot capture all of that revenue, but if it could, then that $4.2 billion annualized revenue rate from Red Hat would be somewhere between $40 billion to $80 billion in total addressable market. If IBM can get half of that, then the Red Hat deal for $34 billion can pay for itself all that more quickly and, presumably, IBM can grow that $19 billion back like a salamander losing a tail.