IBM Reports 4Q2012 Earnings: Full Speed Ahead

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IBM reported its 4th quarter and full year 2012 financial results yesterday. Wall Street seemed impressed with the results, propelling IBM's stock price over 4% higher in after hours trading.

I like to take a look at the zEnterprise hardware results which IBM generally reports not because one quarter is particularly important, and not because IBM's hardware sales are all that indicative of the growth in the overall mainframe ecosystem. That said, they can give us some clues what's going on.

The clues are great. IBM's zEnterprise servers were the standout in the whole earnings report, with revenues (i.e. sales) up 56 percent in the 4th quarter (year to year). That's not necessarily a complete surprise since the 4th quarter was the first full quarter of availability of IBM's new zEnterprise EC12 model. However, Wall Street had some concerns that customers would hold back on their purchases due to economic uncertainties. That didn't happen with respect to IBM, it would appear. Also, IBM pointed out that zEnterprise revenues grew a whopping 68 percent in their growth markets (the countries outside the United States, Western Europe, and Japan). That portends well for zEnterprise growth, because those economies are growing faster. More zEnterprise customers in more countries growing faster is great for the entire mainframe ecosystem. (I would advise mainframe professionals to be aware of opportunities that might be outside their own borders.)

"MIPS," a measure of mainframe computing capacity, increased 66 percent. I've pointed out this simple math before, but here it is again: revenues were dramatically up, and capacity shipped increased even faster. That means IBM continues to offer lower mainframe capacity pricing to its customers. One of the common industry myths is that the mainframe market is a monopoly. Not in my view, and declining unit prices is consistent with a highly competitive server market. IBM is the most successful enterprise server maker, and there's no better enterprise server than zEnterprise (sporting those wonderful 5.5 GHz cores and extremely high qualities of service), but IBM keeps increasing its price competitiveness. That's exactly what I want to see at least as a long-term trend: IBM succeeding (to keep funding strong research and development efforts for even better products), and customers enjoying a healthy share of that success with both progressively higher business value and lower prices ("value for money").

IBM also said that they shipped the greatest amount of mainframe capacity they've ever shipped in history in the 4th quarter. Yes, some of that growth is attributable to "organic growth," which is the natural increase of transaction and batch volumes among existing applications. However, keep in mind that much of the developed world is in recession, and economic activity is not growing terribly fast there. So I think it's very fair to assume that much, maybe most, of this capacity growth is attributable to new applications, migrations of existing applications that were running elsewhere onto zEnterprise, and new customers. IBM didn't provide quite that level of detail, but I think that's a reasonable conclusion.

IBM doesn't break out its software and services businesses to identify which parts are attributable to zEnterprise. It's probably impossible to precisely calculate a "What if IBM didn't have its zEnterprise servers and somebody else did?" counterfactual. But most analysts conclude that IBM's zEnterprise business is essential to driving IBM's high profitability.

There have been some commentators that suggest that IBM has been de-emphasizing hardware, but I think that's simply wrong. IBM seems to continually reinvent itself, moving to where the ball will be before it gets there, not where it has been. I think hardware will always be a critical ingredient in that success, and more importantly so does IBM if you look at the company's research and development. There's an interesting comparison with Apple here. Apple got out of the X86 server business because, for Apple, that wasn't a business in which they could compete with high value, differentiated products. Apple also got out of printers and digital cameras several years ago, again for the same reason. But is Apple a hardware company? Or is Apple de-emphasizing hardware because Apple keeps distributing more music, movies, electronic books, "apps," and cloud services? Well, yes... and no. It's substantially the same with IBM, albeit in a completely different information technology market segment. (Apple and IBM literally never compete with each other.)

I remember listening to IBM's previous CEO, Sam Palmisano, answer a version of the question "What is IBM?" And he said IBM is not a hardware company, not a software company, and not a services company. It is, he said, for lack of a better word, a solutions company. IBM needs all three parts playing their roles in harmony, and IBM needs all three parts constantly evolving. So if that means IBM should not be in the point of sale device business (a recent divestiture) but should be in the enterprise memory storage and "big data" business intelligence engine businesses (two recent acquisitions), then that's what IBM is going to do. (A lot of analysts have missed this, but IBM has bought some "hardware" companies lately. I put the word hardware in quotes because the reality is that it has been a long time since hardware has been purely mechanical or electromechanical. Most "hardware" products are a blend of hardware and software.) Both of the latter hardware-related acquisitions are highly relevant to zEnterprise, in the form of the DB2 Analytics Accelerator as an example.

Anyway, I think analysts that focus only on one or a couple of the "big three" parts of IBM miss the big picture. Fortunately so have IBM's competitors.

by Timothy Sipples January 23, 2013 in Financial
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