IBM Announces 2Q2013 Earnings: zEnterprise Even Better

From time to time I post updates on IBM's earnings reports, as I did last quarter. The caveats I included then still apply.

That said, zEnterprise had yet another fantastic quarter: revenues up 10% (11% at constant currency) and capacity shipments up 23%. That's yet another big server marketshare gain for zEnterprise. zEnterprise was also a very bright spot in IBM's earnings report. Thanks to all the current and new zEnterprise customers that are showing new and renewed appreciation for the unique competitive advantages of zEnterprise.

IBM's other hardware product lines had a tough quarter, but that's sometimes how it goes and why IBM's diversification is a strong advantage. Non-mainframe UNIX servers had another dreadful quarter in particular — HP and Oracle/Sun continue their UNIX server slide into oblivion — and IBM gained marketshare in that segment despite a 24% (constant currency) slide in its Power server business. As I've said before, my best guess is that the UNIX market continues to split with many of those UNIX workloads moving to Linux (including to Linux on zEnterprise, which is picking up workloads from HP and Oracle UNIX server retirements) while others are moving to high-end highly virtualized Power servers. However, like all servers, Power servers are subject to model cycle swings.

I don't see any way that HP and Oracle fix their UNIX server businesses. I predict that both vendors will soon wrap their operating systems into virtualization packages to license and to run them on X86-based hardware in order to cut costs and to support their remaining few customers' workloads that must run on HP-UX, VMS, and Solaris. (Sun already effectively did that with its Solaris on X86, so Oracle is somewhat better positioned in not angering its remaining UNIX customers too much.) I don't know what HP does with NonStop (formerly Tandem), but it won't be pretty.

UPDATE: IBM's CFO Mark Loughridge mentioned on the earnings call for analysts that he expects another double digit revenue growth quarter for zEnterprise in the third quarter. Wow.

UPDATE #2: IBM has posted the charts Loughridge used for his presentation to analysts. One of the charts indicates that zEnterprise's gross profit margin declined in the second quarter, although I haven't found other details. My best guess, recalling previous earnings reports, is that IBM was selling more zEnterprise capacity upgrades a year ago (2Q2012) on existing machines relative to new machines. This past quarter, if I'm right, the mix shifted more toward physical machines that can later be upgraded. Both new model deliveries and capacity upgrades are reportedly profitable, but upgrades are more profitable. Said another way, if I'm right this decrease in the gross profit margin is actually good news because that means IBM shipped more new physical zEnterprise machines (some to brand new mainframe customers presumably) and did not "coast" on capacity upgrades. Then those new model machines can be upgraded, so we would expect that red arrow to turn into a green arrow if/when IBM's mainframe customers upgrade those machines. We really don't have enough financial data from IBM to prove or to disprove this hypothesis, but it seems like a reasonable understanding of the model cycle effects.

A couple other points jumped out of Loughridge's presentation and comments. The next quarter (3Q2013) is the first quarter when zEnterprise revenues will be compared against the quarter with the first sales of the zEnterprise EC12, a model that has already proven wildly popular. Yet Loughridge is predicting another double digit revenue growth quarter for zEnterprise. That's interesting.

Another point is that Loughridge spoke again about a possible divestiture in 2013 or 2014. That's not unusual: IBM routinely divests particular businesses that don't seem like a good fit for IBM's business model. For example, in 1934 IBM sold its food scale business to Hobart, and Hobart still runs that business very successfully. As another example, IBM sold its hard disk spindle business, a business IBM invented, to Hitachi a few years ago. A lot of analysts think IBM is contemplating divesting its System x (X86 server) business, and there have been press reports that IBM discussed the idea with Lenovo but did not reach an agreement. Maybe, maybe not — I don't automatically believe everything I read. But I have a couple reactions to that possibility. One is that IBM seems to have a good track record protecting customers in both acquisitions and divestitures. IBM acquires businesses to grow them, and that means encouraging existing customers to buy more and attracting new customers. That has to be done the old fashioned way, with product improvements, integration, better service, etc., and IBM generally seems to do that. IBM also has a very good track record finding excellent stewards for its divested businesses. The other point I'd make, which I've made before, is that analysts that say IBM is "getting out of the hardware business" are flat out wrong. It's much more correct to say that IBM has been adjusting the mix within its hardware businesses, in recent years buying Netezza, DataPower, and Texas Memory Systems to pick three hardware company examples. Hardware, software, services, and financing are all important, but it's the flexible combination that's magic. The three "hardware" examples I mentioned are all highly solution-focused examples, and that's squarely where IBM wants to be. The strategy is conceptually simple, but it's also a strategy that's very difficult for IBM's competitors to mimic successfully.

by Timothy Sipples July 17, 2013 in Financial
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