Big Blue defies server crash with Q1 profit
Mum on Sun, Oracle, Cisco
Despite some pretty steep revenue declines - particularly in server lines - that drove IBM's overall sales in the first quarter of 2009 down 11.4 per cent to $21.71bn, net income only fell by 1 per cent to $2.3bn. And thanks to some $1.8bn in share buybacks, earnings per share rose by 3.7 per cent to $1.70 a pop.
Either Big Blue is a genius IT company or it is burning its furniture to generate electricity to power the air conditioning to keep its business cool during the economic meltdown. I sure can't tell which it is. I can only tell you that what IBM has been doing has worked for the past few years, and it still seems to be working.
IBM generated $1bn in free cash flow in the quarter, and it has $12.3bn in cash and equivalents in the bank with which to do acquisitions and share repurchases, but then again, the company also has $9.9bn in short-term debt and $21.1bn in long term debt. Of that $31bn in total debt, $23.4bn of it is associated with its Global Financing operations, which finance equipment purchases for the reseller channel and for end users).
With $7.6bn in debts not associated with Global Financing, you can see why IBM was a little hesitant to shell out $6bn or so to acquire Sun Microsystems and put a serious damper on its profitability in 2009 and beyond while blowing its entire cash hoard. Without cash, IBM would not have the extra money it might need to boost earnings per share through cash buybacks.
Sam Palmisano, IBM's chairman, president, and chief executive officer, gave the same old speech he always gives when IBM does its quarterly announcements, and he did it in a statement rather than actually being on the conference call with Wall Street analysts after the market closed today.
"IBM continued to perform well in a very difficult economic environment," Palimisano wrote. "This was due to our long-term strategic focus: shifting into software and services, divesting of commodity businesses, and creating solutions that help clients reduce cost and conserve capital. At the same time we have a disciplined approach to cost and expense management giving us a strong financial position.
"We are well-positioned to continue to move aggressively and leverage our strong cash performance to make the most of the opportunities that arise, including smarter planet initiatives and other strategic options. We remain ahead of pace for our 2010 roadmap of $10 to $11 per share."
What Palmisano did not add was "and that is because we were not silly enough to buy Sun Microsystems." But just because the PR people at IBM didn't type that for Palmisano doesn't mean IBM's chief wasn't thinking it, as many IBMers most certainly are as Big Blue turned down a Sun takeover deal and this morning  Oracle has come out of nowhere (well, Redwood Shores, actually) to save Sun from itself and buy it for $5.6bn.
The declines in IBM's Systems and Technology Group - which makes and sells processors, servers, storage, operating systems, and sundry electronics for retailers - were breathtaking. The Systems and Technology Group reported sales of $3.2bn, down 23 per cent. It is a testament to how much IBM has changed since the early 1990s that such declines are not killing the company. (Service used to be included with much more expensive iron. Now it is a separate budget item, and I suspect some days that the net price of systems burdened with people costs as well as hardware and software costs have not changed much in two decades when adjusted for inflation).
Mark Loughridge, IBM's chief financial officer, said during the call with Wall Streeters that revenue for System z mainframes was down 19 per cent (but only down 12 per cent at constant currency in the local markets where deals were done, with the 7 point spread being the effect of translating those deals into dollars and bringing them on home to Armonk, New York). The aggregate amount of computing power for mainframes that IBM shipped in the quarter actually rose by 18 per cent, Loughridge said, with MIPS shipments of so-called specialty engines that run Linux, WebSphere, or DB2 accelerators up 20 per cent and Linux-related MIPS up more than 50 per cent.
This is the fifth straight quarter where MIPS shipments were up by double-digits, indicating that the System z10 product cycle is doing as well as can be expected given the state of the economy. In growth markets, Loughridge said that System z mainframe sales grew by 60 per cent at constant currency, which translated in 37 per cent growth when converted to dollars.
IBM's Power Systems, which are no longer broken out separately as AIX and Linux platforms and OS/400-i platforms, showed had 35 per cent growth at the high end of the product line (which means Power 570 and Power 595 boxes, I believe). But overall sales of Power Systems fell by 2 per cent. However, in constant currency, Power Systems sales were actually up 5 per cent. IBM believes that it took 4 points of market share in the RISC/Itanium server market (and is probably counting i-based server sales as if they were Unix boxes to get that number). Loughridge said that Big Blue had 62 competitive replacements in the first quarter where its Power Systems machines kicked out other vendors' boxes, and half of these involved sales of over $1m in server gear.
The System x x64-based server line, which includes rack and tower machines as well as BladeCenter blades running Xeon and Opteron processors, continued its slide for the third quarter in a row, with sales down 27 per cent in the quarter.
"The demand for x86 solutions continues to soften as customers virtualize workloads and consolidate on more efficient platforms," Loughridge declared. I simply don't believe this is the only reason why IBM's System x business has been falling for three quarters. Something else is going on, especially since IBM makes the most scalable x64 boxes on the market and should be benefiting from any virtualization-driven consolidation. I think Hewlett-Packard and Dell are beating IBM to win deals at SMB shops, plain and simple, just like HP has come to dominate blade server sales as IBM was doing a few years ago.
In other parts of the Systems and Technology Group, storage revenues dropped by 20 per cent, with double-digit declines in both disk and tape hardware sales. IBM's sales of chips and other stuff through the Microelectronics division fell by 36 per cent in Q1, and retail store systems fell by 38 per cent.
By comparison, Software Group had a pretty decent quarter and contributed mightily to Big Blue's bottom line. Even as revenues for Software Group fell by 6 per cent (up 2 per cent at constant currency) to $4.5bn, pre-tax margin for this group rose by 2.9 points to 25.9 per cent. IBM's WebSphere middleware posted a 5 per cent rise in Q1, but database sales (mostly DB2) fell by 8 per cent.
Tivoli systems management and storage software sales fell by 1 per cent and Lotus groupware sales slid by 12 per cent, but Rational development tools saw an increase of 9 per cent. Loughridge was very keen on bragging that about two-thirds of IBM's software sales are akin to annuities, in as much as customers pay monthly or annual fees to use the code. It is great to have a business built on legacy software that is hard to move, unless you are the customer trying to cut costs in a down economy.
And if you are, well, who you gonna call? Global Services, which is now split into Global Technology Services, which does strategic outsourcing as well as supporting IBM's hardware and software, and Global Business Services, which does business process outsourcing and re-engineering, systems integration, application outsourcing, and other unspeakable acts of consultancy. Global Technology Services posted sales of $8.8bn in the first quarter, down 10 per cent as reported (but only down 1 per cent at constant currency). But once again, thanks presumably to firing a whole bunch of people and off-shoring some of its own people's work, IBM was able to boost profit margins in GTS by 2.3 points. Margins in GBS were largely unchanged, and sales fell by 10 per cent as well to $4.4bn.
In terms of contract signings in the quarter, IBM's outsourcing business was a bright spot inside GTS, with long-term signings up 8 per cent to $5.6bn; within GBS, long-term application outsourcing contract signings were up 44 per cent to $1.4bn. (Yeah, I know, why are the two outsourcing businesses in different places? Because IBM needs to pump up GBS numbers, I guess). Global Services had a total of $12.5bn in contract signings in Q1, and IBM's total services backlog stood at $126bn as the quarter ended. That is five quarters worth of revenue that is more or less waiting to be plunked into the bank.
By geography, the Americas region is still IBM's biggest market, but sales declined by 7 per cent to $9.3bn in the quarter. Sales in EMEA fell by 18 per cent to $7.2bn, while revenues in the Asia/Pacific region fell by 6 per cent to $4.8bn. OEM revenues (mostly chips to game console makers) are always booked in the States and they fell by 38 per cent to $461m.
When asked about IBM's rumored deal to acquire Sun, which fell through two weekends ago, and Oracle's proposed acquisition of Sun, which was announced this morning, Loughridge didn't offer much insight into IBM's thinking. He said that Oracle and Sun have been partners for two decades, and that the main result has been market share gains for Big Blue.
"We have been competing with Sun, and we know Oracle inside and out, and now they have the same address and the same mailbox," Loughridge said. He then bragged that IBM has done more than 100 acquisition deals for over $20bn since 2000 and that it uses a disciplined and precise process to wring sales and profits out of those acquisitions, before brushing off a question about Cisco's entry into the system space by saying that IBM was going to continue to play to its own system strengths, next question please. . . .
And many, many times on the call Loughridge said that IBM would meet or exceed its stated goal of raking in $9.20 of earnings per share in 2009, a stepping stone to the $10 to $11 per share that is a goal for 2010 that Loughridge and Palmisano have been pointing to like the upper deck at Yankee Stadium (the old one, not the new one where the Yankees get whipped) for the past year.
There's very little question that IBM can bring in these profits for quite a while, perhaps for years. There is no way that Big Blue would say otherwise unless it couldn't hit the numbers. But with Oracle wanting to be in the systems space and able and willing to cut a lot of costs out of Sun, and Cisco wanting to get a bite of the systems pie, too, IBM may find 2011 tough sledding, just like the uptake of Unix servers nearly killed the company two decades ago when they swarmed the mainframe.
Which, of course, is why IBM is talking up its "smart planet" computerization of all kinds of transportation systems and electric and water infrastructure. As Loughridge pointed out, there's about $5 trillion in stimulus money that Uncle Sam and a number of other governments have kicked into the global economy, and IBM reckons that it can chase about $3 trillion of that opportunity. The real question is whether this non-IT infrastructure biz is Plan A or Plan B for IBM some years from now. ®