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  • Power Systems Still Climbing Despite This Weird Economy

    October 30, 2023 Timothy Prickett Morgan

    Back in the old days, IBM used to talk about System z, Power Systems, and storage as separate things because they are, largely, separate things. Even if customers of the mainframe and Power platforms sometimes buy IBM storage for their machines, and even if some of that storage is actually based on Power platforms themselves.

    But to be able to brag about the System z business every quarter and to make the rest of its Infrastructure group look like a bigger thing, Big Blue merged its Power Systems and Storage divisions into something it has called Distributed Systems for the past several years. And the net effect of that is that we can’t see that the Power Systems business is doing better than the growth – or lack thereof – in the relatively new Distributed Systems division might lead you to believe. And so, each quarter when IBM reports its financial results, we try to reckon how much revenue IBM gets from selling Power Systems machines to end user customers directly as well as to channel partners (like the one you very likely bought your Power Systems platform from), outsourcing partners (like its former Kyndryl consulting business), and other IBM divisions (like the Storage piece of Distributed Systems, which makes the DS series arrays as well as GPFS clusters for supercomputers based on Power iron).

    It is a tricky business indeed trying to figure out how the Power Systems business is actually doing, but on a call with Wall Street analysts going over IBM’s financial results for the third quarter of 2023, Jim Kavanaugh, the company’s chief financial officer, threw us all this tidbit: “Distributed Infrastructure revenue was down 6 percent as compared to a strong growth in last year of 21 percent as we introduced innovation across Storage and Power10. This quarter, we had growth in Power offset by declines in Storage.”

    With this, we can do some guesstimating. So let’s go through the topline numbers and drilldown to get into the good news that the Power Systems platform is growing, and has been for the past three years as far as we can tell.

    In the quarter ended in September, IBM’s overall revenues rose by 4.6 percent to $14.75 billion, and gross profits rose by 8 percent to $8.02 billion. We think the difference in growth has been at least in part caused by IBM’s own adoption of generative AI functions within its own back office operations, something that Big Blue has been vocal about in recent quarters. IBM had a huge $5.8 billion write-off against its pension obligations in the year ago period, which pushed it to a net loss of $3.21 billion, so the $1.7 billion net income it had felt pretty good by comparison and represented 11.6 percent of revenue – the best profit rate the company has turned in since Q4 2021, when it was 14 percent of revenues. IBM’s average net income since it recast its financial model in 2019 is 9.2 percent, so now you have a comparison.

    In general, the IBM businesses are humming along, with the usual ups and downs for infrastructure and systems software, as you can see from the chart above. Infrastructure sales were particularly strong in the year-ago period, and were relatively normal if you gauge against prior third quarters. The Power10 and System z ramps were both accelerating in Q3 2022, which makes for a tough compare as Kavanaugh correctly pointed out.

    In the September quarter, IBM booked $327 billion in revenues in its Infrastructure group, down 2.4 percent and pulled down by decline sales for infrastructure support, which were off 6.8 percent to $1.36 billion. Hybrid infrastructure – which is IBM lingo for System z, Power Systems, and Storage sales combined and which is far and away not hybrid but on premises gear – had $1.91 billion in sales, up a point. Pre-tax income for this hardware rose by 38.2 percent to $387 million, in part because a lot of customers are probably doing latency capacity activations on systems they already own as well as buying new machines.

    That hardware supports a vast annuity-like software base, particularly on the System z mainframes, which rose by 7.8 percent to $6.27 billion in the quarter. The Red Hat business had a terrible consulting and services drag through in the quarter, apparently, but still rose by 9 percent to $1.64 billion. If you look at the core Red Hat Enterprise Linux business, it was “growing double digits,” according to Kavanaugh and the OpenShift and Ansible businesses “were north of 40 percent” in their growth rates. The Hybrid Platforms & Solutions division, which is other operating systems and middleware, minus Red hat accounted for around $2.9 billion in sales, we reckon, up around 7 percent, and transaction processing systems accounted for $1.76 billion, up around 9 percent in our model.

    No matter how it talks about itself, IBM is really a systems company, and for all of its talk about AI, IBM chief executive officer Arvind Krishna admitted that the company only booked a few hundred million dollars in AI-related sales in Q3. So we try to figure out how that underlying systems business is doing each quarter.

    If you look at that base systems business – hardware, operating systems, tech support, and financing for IBM’s own systems, including the systems parts of the Red Hat stack – we reckon that the “real” IBM systems business generated $7.42 billion in sales, up 3.3 percent. If you back out Red Hat, which often runs on non-IBM systems, then the core, native IBM systems business generated $6.38 billion in sales in the third quarter of 2023, up 2.4 percent. That’s not great, but it is also not terrible.

    So, how did Power Systems do? It is very hard to tell, given the way IBM talks about it – or rather, doesn’t talk about it.

    Our best guess is that the Power Systems business was up 3 percent as reported and 1 percent at constant currency, accounting for $431 million in sales in the quarter, and that Power-based machines sold to the Storage division accounted for an additional $63 million, down 6 percent and we think down a whole lot less than the storage business overall.

    If you look carefully at the chart above, you will see an interesting trend in the quarterly Power Systems sales. The highs in the second and fourth quarters are trending down and the lows in the first and third quarters are trending up and it looks like they are converging to a kind of middle ground. I would expect that if the business was transforming from a transactional one of selling boxes to a services one selling capacity per month using cloudy pricing. But there is no way any representative portion of Power Systems sales is actually due to a transition to subscriptions. It is just neat that the market seems to be converging to a more level sales rate.

    Now, here is the good news. If present trends persist, we think the Power Systems business will be up in 2023, the third year of revenue growth for the platform:

    We think that there is a chance that the Power Systems business will grow by 2 percent in the final quarter of the year, which might be up 4 percent at constant currency, which would put sales for Power Systems hardware at $1.45 billion for the year.

    With a Power10+ kicker in 2024, IBM could even grow it more from there. But as far as we know, there is no plan for a Power10+ kicker, even though we have strongly encouraged for there to be one.

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  • What IBM i Shops Are Thinking About Right Now
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