IBM Announces 2Q2012 Earnings: Mainframe Sales OK

Per usual I like to inspect IBM's latest earnings report to understand what's going on with the company that produces the world's most important enterprise servers. I do, however, caution that zEnterprise hardware sales are but a small fraction of the "mainframe ecosystem" and even of IBM's mainframe-related businesses. It's similar to how the Dow Jones Industrial Average, which includes IBM, represents only a tiny piece of the overall U.S. stock market.

Anyway, with that caveat aside, the whole of IBM reported profits that exceeded Wall Street's expectations. Total sales were down 3 percent, but if adjusted for currency effects they would have been up 1 percent (quarterly basis, year over year). Profit margins improved, too — up 1.2 to 1.5 percentage points, depending on the measurement standard. IBM's profit stream is an enormous competitive advantage, because it means the company can continue plowing some of its profits back into vital research and development, including enterprise server development. It's very hard for a company to sustain such a commitment over a long-term basis without that sort of financial security. HP and Sun are good counterexamples.

Turning to the mainframe hardware revenues, as expected they were down. Unexpectedly they were not down much: 11 percent (9 percent at constant currency) versus 7 percent for IBM's total hardware business. Servers, as most of us know, have strong model cycles, so what you want to see in a strong server business is big growth at the beginning of the cycle followed by much less big decreases in sales. And that seems to be what's happening. You don't want to see continuously plummeting sales, as with Oracle, or sales retrenchment into lower value product mixes, as with HP.

The traditional measure of mainframe capacity shipments, MIPS, declined only 8 percent. Once again that means the average price per MIPS decreased — that's just simple math. That's good if you're a mainframe customer, obviously, and it's also good for the IBM mainframe's market competitiveness. (Although I think that's more psychological at this point, for reasons I've explained previously. Price psychology is important, certainly, but mainframe computing hasn't been expensive for a long time.) Also, as IBM's CFO pointed out, IBM's mainframe hardware profit margin increased in the quarter, as you might expect at this point in the model cycle. Profit is the fuel for R&D.

However, I think IBM's CFO disclosed the most interesting mainframe data point in response to an analyst's question. Many people want to know that the mainframe ecosystem is expanding in terms of the customer base. Well, the zEnterprise hardware business was up 11 percent in IBM's so-called "growth markets." That's promising. We don't know how much of that sales growth is attributable to brand new mainframe customers, but that's exactly where you'd expect to see most of IBM's new mainframe customers, weighted toward developing countries. Those are the countries where I mostly work, so I'm particularly happy to see that positive number.

IBM's CFO Mark Loughridge also said that IBM gained marketshare in its high-end server businesses which obviously include its zEnterprise mainframes. Said another way, sure, IBM was down a little in the quarter, but IBM can confidently predict that everyone else was down a lot more in the same quarter. The world needs servers, even amidst model cycles and economic challenges, so winning the marketshare battle helps assure future success. IBM's history is replete with examples of its prospering during lean times.

I'll close with this question and then answer it: does the world need high-end servers, i.e. hugely vertically scalable, mission-critical, intensely virtualized, large memory, high performance-in-every-way (including I/O) enterprise servers? I say yes, emphatically — and more emphatically every day. The world desperately needs these servers — not for everything, but for a lot of things. Not everyone agrees with me, but IBM does. What do you think?

by Timothy Sipples July 18, 2012 in Financial
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