Breaking Analysis: Spotlight on IBM’s Systems Business

>>From the SiliconANGLE media office in Boston, Massachusetts, it’s theCUBE. Now here’s your host, Dave Vellante.>>Hi, everybody, welcome to this edition of theCUBE Insights powered by ETR. In this breaking analysis,
we’re going to look at IBM’s Systems business
and, specifically, the IBM system Z, and
talk about the impact that it’s going to have on IBM financials. Now, Alex, if you would kindly
bring up the first slide. So this is data from ETR’s spending intentions survey
for the second half of 2019. They asked customers, compared
to the first half of 2019, what are your spending intentions on the second half of
2019, specifically for IBM? So you can see the N here is 448 customers out of their panel of 4500,
of which around 11 or 1200 answered this question specifically cited that they were IBM customers. What this data shows
is 21% of the customers said we’re going to increase
spend in the second half relative to the first half with IBM. 52% said we’re going to stay flat. 14% said they’re going to decrease. You see 6% said we’re
going to basically leave the IBM platform and 7% said we’re going to bring on IBM
as new, we’re a new customer. So, if you take the people
that are spending more and new and subtract out the leaving
and the spending less, you get a net score, and
you get a net score of 8%. Now we’ve been sharing
with you this ETR data over the last several weeks and months. 8% is not great. IBM, according to ETR spending surveys, they’re losing share relative
to the overall market. We’ve covered this pretty extensively. We covered the Red Hat acquisition and talked about how that IBM intends to supercharge its cloud business. Specifically with Red Hat, I’ve said I’ve been on record,
saying this is largely a services play where they’re
going to basically take Red Hat as an application
development platform and help their customers
modernize their systems from using their large
services footprint to do that. And I want to talk for a moment about the IBM business overall. IBM is all about mission-critical work. The IBM Z, their high-end
systems, their related database, it’s all about mission-critical work. IBM shared some data
with analysts recently where they talked about,
if you look at IBM Z, IBM Security business, its database, particularly Db2, its middleware, its application management services, and its infrastructure, and
all that set of consulting work that goes around that. Add that up, it accounts
for 60% of IBM’s revenue. So this is why I want to spend
some time talking about IBM Z. I mean it’s kind of a
boring but important topic. It used to be the heart of IBM’s business. It used to drive entirely
their income statement, but in fact, today, it’s
still very critical. All those pieces that I mentioned account for 60% of that business. So Z is critical for driving
IBM’s Systems business and that gives air cover
for IBM’s business overall. So, Alex, if you bring up the next slide. What I’ve done is just pulled
out some quarterly data of IBM’s Systems revenue overall, and then juxtapose it
against IBM’s Z revenue. This is growth, this
is just percent growth. So the blue is IBM Z
percent revenue growth relative to the previous year. This is in constant currency, by the way. And as well, it excludes the elimination of IBM’s Systems X business,
the Intel-based business, so it’s normalized for that. And then the orange is
the overall Systems growth so you can see that the
blue grows virtually immediately after IBM
announces a new system. So, for instance, in January of 2013, IBM announced the Z13. We were there with theCUBE to cover it. We talked to a number of practitioners. What big banks and big
mainframe customers do and, by the way, 25 of the
world’s top 25 banks run on Z. Huge proportion of retail giants run on Z. Why, because it is the system of record, and the top system of record, along with Oracle, in the world. I’ll talk more about
that, but you can see here Z13, so we talked to
a lot of practitioners at the January launch, and they told me they’d buy this thing sight
unseen because they know it’s going to drive revenue for them. If they can get more power,
more performance, lower cost, it drops right to their bottom line. So you can see 2016, even though there was a kicker in there, of the next generation,
not next generation, but a kicker to the Z,
I didn’t show it here, but bad year in 2016 in terms of growth. And you can see the blue is
proportional to the orange. It drags it down in here. Z14 is announced and you can see, when the Z14 was
announced, in July of 2017, just right after that, boom. Big uptick in Z revenue and
proportional Systems revenue. So you’re on this two-year
cycle of Z announcements and you can see 2019, in the
first half, has not been great. IBM just announced the Z15 in September, so we fully expect that in Q4,
you’re going to see that uptick. So kind of wanted to share that with you. Next slide, I just want
to make a couple of points about IBM’s Systems business. It’s about an $8 billion business overall in terms of annual revenue. It comprises Z, power, and storage. It’s as they say, System
Z drags a lot of software. It drags storage, it drags services. It’s about a 53% gross margin business. The storage business is actually quite a good gross margin business, I think, probably higher than power. The server business is not
the greatest gross margin. I think mainframe is still pretty good. IBM and Oracle dominate the
business for systems of record: Oracle with Exadata and IBM with Z. Now you might say, hey, Exadata is growing and Z is, I just showed you,
the sort of fluctuation, but overall, it’s sort of flattish. Maybe it can eke out growth. It actually can show
good growth in one year, but if you normalize
it over a couple years, it’s pretty much a flat
business or declining business. So you might say, well,
Oracle X has grown, but that’s ’cause Oracle’s replacing its entire hardware business and much of its related
software business with Exadata, all that wood behind one arrow, whereas IBM has a more
diversified portfolio, and so that’s kind of
apples-to-oranges comparisons. Now the ETR data shows
that the storage intentions for the second half of 2019 really flipped to positive territory. Servers were still negative but improving. And so, as I showed you
in the previous slide, I definitely would expect
the Systems business to have an uptick in Q4 and it’s dragging storage with it. IBM synchronized the storage
announcement, the DS8000… I am not great with model numbers but the recent storage announcement with the mainframe announcement, I’ll make some more comments about that. But it seems that IBM’s
trying to do a better job of synchronizing that. IBM’s also going to smooth out
its Systems revenue, I believe. I mean, right now, it’s very cyclical, but I’ll make some comments
about that in a moment. So IBM system Z and Exadata are unique in that their IO is tightly integrated. These are purpose-built systems and the storage and the
IO are purpose-built for the systems of record, so they’re very, very low latency. Give you an example, Oracle Exadata, in recent announcements
at Oracle OpenWorld, I think 18 microseconds latency. IBM, with its recent Z announcement,
I think, is even lower. I want to say 15 microseconds
but don’t hold me to that. Whereas, if you compare
that to traditional systems, you’re talking about
maybe 200 microseconds, in other words, those systems
that aren’t purpose-built for systems of record with integrated IO. The IO is hardwired with
custom silicon and A6 and so it’s ultra, ultra-fast IO which means you can push 10
times the IO through the system. So very, very high performance relative to what you saw
in previous generations. Why do I spend so much
time talking about this? Because this is a harbinger for
future Systems developments. Talking, within two to three years, you’re going to see the mainstream systems with this type of low latency. So now, you might also say, wow, that means that the IBM
and the Exadata business are in big trouble. No, these systems are
not going to be replaced, they’re not going to be migrated. It’s too risky, it’s too expensive. We’ve talked about that a lot on theCUBE where it just doesn’t make business sense for people to convert off the Z mainframe. There’s too much custom code. They’d have to freeze that code for many, many months, maybe even longer. They’d risk their business. They’re going to make much more money purchasing the next generation of system as long as the Z mainframe continues to add function, which it’s doing. Same thing with Oracle Exadata. Years ago, IBM announced
support for Linux. Obviously, Red Hat is now
another key piece of that. In the recent Z15 announcement,
Encryption Everywhere. They announced a hybrid cloud so basically bringing the Z to cloud. Really strong security focus. This cloud piece is interesting. We talk a lot about Cloud 2.0. Bringing the Z and the
systems of record to cloud is something that IBM has said that it intends specifically to do. That will begin to potentially smooth out IBM’s Z revenue. You know, it’s ironic. In the latter part of the 1980’s, kind of a financial game
that IBM was playing, they converted their rental base, which was a monthly income
stream, to purchase. When they did that, it created the effect of showing up on the income statement and kind of hiding the trouble
that IBM was really in. When that transition
ended, IBM really tanked, and that’s when IBM got into big trouble, the whole downsizing trend. Gerson had came in, they bought PWC, and really transformed the company. But the Z as the system of record, or the old 3090, has lived on. Now we’re seeing that
dynamic come full circle where, over time, IBM can shift from an upfront pay to a subscription, which is, as they say, coming full circle. It’s going to be interesting to
see how that transition works. The other point again. The storage seems to be
synchronizing its product cycles with Z at least at the high end. And so this is likely
to carry through the Q4. We see, from the ETR spending data, that storage intentions are up. I think the net score was up 5% versus a negative from the previous quarter. Servers overall were still down. They don’t have a question specific to Z, but I would fully expect
that Q4 this year, you’re going to see a
nice uptick in Z revenue. And, as I pointed out
before, with that 60% number, this is going to provide
another halo effect for IBM’s overall business. Will it be enough to propel the stock? Probably not, this stuff is factored in, the analysts understand
these product cycles, but it’s something that I
wanted to shine a light on because, again, it’s one
of these important topics that not a lot of people talk about. People roll your eyes when
you talk about the mainframe, but the mainframe is
here, it’s alive and well, and what I call “mainframe”,
Oracle Exadata and IBM Z, are really the two companies that are prominent in that space. And, while they might
compete, to my earlier point, you’re really talking about each company having its own install base and, as long as they
keep investing in R & D and keep those product cycles coming, I would expect that this business is going to be healthy yet
cyclical for a long, long time. This is Dave Vellante for
theCUBE Insights powered by ETR. We’ll see you next time,
thanks for watching. (upbeat electronic music)

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