Proper accounting of the electricity company

October 25, 2021

Timothy Pricket Morgan

Big Blue may be preparing for its managed services company Kyndryl spin-off, now slated for early November, and its new financial presentations, which we reviewed two weeks ago, but that task is yet to come. completed and until it is, we still get the same financial view from IBM for the third quarter of 2021 ended in June. It was not a particularly memorable quarter for the IBM Systems Group.

But it looks like IBM will be able to prepare for a better 2022, with Kyndryl taking over a huge amount of software and a reasonable amount of iron as it leaves its parent company. To be specific, next year Kyndryl will spend about $500 million on System z and Power Systems iron and IBM technical support for the platforms that run its managed services business, while spending about $2 billion for mainframe software rentals, various Red Hat software licenses, and a handful of Power Systems software, security software, and database and AI software. That would have been all of IBM’s internal sales between groups and not reported externally if Kyndryl hadn’t been created, and now IBM can count on $2.5 billion a year from Kyndryl – and presumably with a healthy margin – for the foreseeable future. And that will be about a quarter of all of IBM’s remaining $10 billion in free cash flow for 2022.

We wouldn’t be surprised if Kyndryl were to buy a big Power10 iron in the fourth quarter of this year, by the way.

Also in 2022, System z16 Telum mainframes will ship, which will help drive hardware sales for at least two quarters, possibly three, and the Power10 rollout will also accelerate here with big iron shipments at the end of 2021 and as 2022 kicks in, then the Power10 entry machines may arrive in May or June of next year, starting the next cycle.

It’s hard to say what IBM’s Power Systems plan will be outside of serving its existing customer base – we don’t hear much about hybrid CPU-GPU systems supporting HPC and AI workloads like we have. done during the Power8 and Power9 generations, which is a little disconcerting given the explosive growth we’re seeing in these two technical computing markets. To be fair, there’s a lot of SAP HANA business, and IBM earns its share of it, and there’s somewhere on the order of maybe 150,000 IBM i and AIX stores globally – call it a breakdown 120,000/30,000 – and there are only 3,000 HPC centers in the world. It is not difficult to determine which Big Blue company should deal with first and where profits can be made.

That said, IBM needs to have a much stronger HPC and AI business, and the management team there has changed everything and, most importantly, the core people who distributed X86 clusters (which used to be the bulk HPC business at IBM) were sold. in 2015 at Lenovo. Perhaps IBM should have bought Lenovo instead of selling the System x business. . . .

Anyway. We have to face what is, not this we hope to be to go to where we want to be.

In the June quarter, IBM’s revenue rose a third of a point to $17.62 billion, but its gross profit fell 3.1% to $8.17 billion and, thanks to higher costs on many fronts – particularly selling, overhead, research, and development costs as well as a higher tax rate – IBM’s net profit fell 33, 5% to $1.13 billion.

The Systems group was not the star of the quarter and suffered a fairly large operating loss as the costs of the “Telum” z16 and “Cirrus” Power10 processors and the development of the systems that use them come home before future deployments. year – and what we assume are higher system costs for the z15 and Power9 machines in part due to supply chain issues thanks to the coronavirus pandemic. (Everyone in the hardware industry is feeling this pain, why not IBM too?)

IBM didn’t have much to say about Power Systems sales, but its chief financial officer, Jim Kavanaugh, had this to say: “Toward the end of the quarter, we began rolling out our next generation Power10, starting by a high-end system. As always, new Power technology is being introduced over time, and mid-range and low-end Power10 systems will be available in 2022. Storage drove revenue growth of 11%, driven by demand for hyperscalers for our tape products and the growth of entry-level all-flash systems. storage following our product refresh earlier this year. In terms of earnings for this segment, the profit margin was down, reflecting where we are in the IBM z and Power product cycles.

Personally, I don’t like the attitude that is changing at IBM regarding Power Systems. It is no longer a foregone conclusion that the world will only use an Intel Xeon processor. The world has changed and there are opportunities for IBM to expand the Power base, not just shrink it over the next five or ten years. But to create a company that has a real future and a real differentiation. I don’t see anyone talking about it, and certainly Ric Lewis, the new general manager of the Systems group, who just arrived from Hewlett Packard Enterprise and who knows the mid-range systems sector, as well as the high-end systems sector , as well as anyone there. IBM needs to stand up and do something to make the combination of its Red Hat stack and its hardware stack better than anything else. And if it can do it – as promised with the OpenPower Foundation and yet to be delivered – then the IBM i and AIX platforms will be healthy too.

Right now, that doesn’t look good for what will likely be a bottom for the Power Systems business. Here is our revenue model for server and storage sales based on Power machines:

The good news is that the third quarter of 2021 was not the worst quarter for Power that IBM has ever seen, but the bad news is that it is the third worst quarter. (As we’ve pointed out before, much of the decline since 2018 is due to China’s desire to have local vendors for key systems, and Inspur’s partnership with IBM likely accounts for about a third of global tech revenue. Power-based servers – but we can’t see that reflected in IBM’s own numbers.

If you drill into IBM’s systems sales and make an estimate by converting its constant currency numbers to reported numbers, the numbers don’t look particularly pretty in Q3 2021. External systems sales were $1.11 billion , down 11.9%, and internal sales to other divisions (such as the part of Global Services that is being transformed into Kyndryl) were $176 million, down 26.7% from one year to the next. Thus, overall system sales (servers, storage and operating systems) amounted to $1.28 billion, down 14.3%. We estimate that IBM’s computer hardware revenue was $803 million, down 13.4%, and operating system sales were $304 million, down 7.9%, and Systems Group gross profit fell 29.3% to $454 million. When you add costs beyond the BOM, including research and development, IBM says it reported a pretax loss of $207 million. This is the kind of loss IBM normally sees in the first quarter of the year, and the third quarter usually does a little better than break even and sometimes quite well but never like a fourth quarter.

We believe, based on our revenue model, that Power-based servers were $191 million in revenue, down 24.4%, and Power-based storage was up 12% to $45 million. of dollars. If we were to throw a number, we think operating systems and core systems software on Power-based machines (but not storage software, transaction processing software, or database software) was maybe $45-50 million, and storage-based software (which isn’t counted alongside hardware in the Systems group but complements the other software division to make it look bigger and more profitable than it is) could have been between 50 and 100 million dollars. Here’s the catch. Database, transaction processing, analytics, AI and developer tools for Power-based machines could be much bigger than all of that put together – and IBM refuses to tell the story of the real business This way.

It’s not just boring. This is detrimental to this electricity company. And me, for my part, I don’t like it a little.

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