Editor’s note: IBM (NYSE: IBM) reported a 13.5 percent drop in revenue for its most recent quarter, stretching its streak of decline to 13 straight. Big Blue shares fell 5 percent in after-hours trading following Monday’s earnings report, which missed analysts’ expectations by 1 percent. Analyst Stephen Belanger examines what’s going on.
HAMPTON, N.H. – In 2Q15 IBM’s corporate revenue declined 13.5% year-to-year to $20.8 billion due to currency challenges and divestitures, as well as continued weaknesses within its legacy hardware, commoditized services and middleware businesses. This marks IBM’s 13th consecutive year-to-year revenue decline; however, the vendor is making progress with its efforts to realign around strategic cloud, analytics, mobility, social and security (CAMSS) initiatives. In 2Q15, IBM reported that revenue from its strategic imperatives increased approximately 20% year to year, as total cloud revenue increased over 50% year-to-date. Additionally, IBM reported analytics revenue increased over 10% year-to-date, while revenue from mobile more than quadrupled and social revenue increased more than 30% year-to-date.
Despite growing traction with its CAMSS initiatives, IBM’s Software and Global Services revenues declined 10.1% and 11%, respectively. Systems Hardware revenue fell 31.7% over the same period, driven largely by the divestiture of its x86 and chip manufacturing businesses. However, IBM reported z Systems revenue increased 9% year-to-year, supported by the second full quarter of z13 availability. Further, IBM’s efforts to expand its Power portfolio and OpenPOWER Foundation helped the company moderate the product line’s revenue decline to 1% year-to-year. TBR notes this is a dramatic improvement over IBM’s 2014 Power revenue decline of approximately 18% year-to-year. IBM’s storage revenue declined 10% year-to-year due to weak high-end disk demand and the wind down of its OEM business. Despite revenue challenges, IBM’s focus on higher-margin product lines enabled the company to increase its Systems Hardware pretax margin 550 basis points year-to-year to 11.8% of revenue.
As IBM continues to invest heavily in CAMSS initiatives, its profitability will be pressured in the short-term — in 2Q15, the vendor’s operating margin of 19.4% of revenue was down 260 basis points from 2Q14. In the long term, IBM’s realignment to higher-margin portfolio areas such as cloud and analytics, consulting and advisory services, and proprietary systems will drive profitability improvement.
IBM bolsters the OpenPOWER Foundation by targeting developers and enhancing workload optimization
Following the sale of its x86 business to Lenovo, IBM is increasingly relying on its Power portfolio and OpenPOWER Foundation to compete with x86 server OEMs. IBM is targeting developers for its OpenPOWER Foundation to expand its portfolio of cloud applications and better compete with x86 server OEMs such as HP, Dell and Cisco. In 2Q15, IBM launched SuperVessel, a free OpenStack-based cloud service, in an effort to attract universities, professors and developers into its OpenPOWER Foundation to create cloud applications in areas such as analytics, machine learning and IoT. IBM is focusing on the price/performance value proposition of its Power solutions, particularly for select workloads such as HPC, to differentiate from competitors’ x86-based solutions. As a result, IBM and its OpenPOWER Foundation will increasingly threaten the x86 server market, particularly in targeted vertical markets such as education. Additionally, adoption will accelerate as IBM continues to bolster the Power value proposition and aligns its portfolio to high-demand technology areas such as cloud and analytics.
HPC is a key technology area in which IBM is using its OpenPOWER Foundation to better address customer demand. The company’s HPC solutions leverage IBM’s Power and storage technologies; OpenPOWER partner technologies such as accelerators from NVIDIA and Xilinx; and networking devices from Mellanox. In 2Q15 IBM and its OpenPOWER partners, Nvidia and Mellanox, announced the Power Acceleration and Design Center in France to provide technical support for developers creating HPC applications using the three vendors’ technologies.
IBM and its OpenPOWER partners have demonstrated a strong roadmap for HPC technologies. New IBM-branded HPC solutions will be launched in 2015 and 2017, and OpenPOWER partners will also offer a variety of Power-based solutions to address HPC demand. IBM provides customers with an alternate to Intel and its roster of 50+ system provider partners in the HPC space. TBR believes the performance and computing advantages of Power-based solutions compared to x86 solutions lends itself well to the HPC market, and IBM will continue to focus heavily in this area to gain share from Intel-based competitors.
IBM demonstrates its commitment to chip innovation with the production of 7 nm test chips
In 2Q15, IBM unveiled its first major breakthrough that resulted from its planned $3 billion, five-year investment in chip R&D, which was announced in July 2014. IBM Research, in partnership with GlobalFoundries and Samsung at SUNY Poly CNSE, produced the first 7 nm test chips. To overcome fundamental technology barriers and shrink its process technology, IBM replaced silicon with silicon-germanium, and leveraged Extreme Ultraviolet (EUV) lithography. While 7 nm transistors are several years away from commercial production, they will offer approximately twice the power density of 10 nm processors, which Intel is planning to release in 2016. In addition to Intel, IBM is facing competition from Taiwan Semiconductor Manufacturing Company, which plans to begin pilot production of 7 nm chips in 2017. However, IBM is the only company that has demonstrated working 7 nm test chips, which TBR believes will provide near-term mind share benefits.
In the future, the power density improvements of 7 nm technology will help IBM address demand in areas such as cloud, big data, cognitive computing, mobility and other emerging technologies. In the short term, TBR believes the announcement demonstrates that despite the sale of its chip manufacturing business to GlobalFoundries, IBM remains committed to chip innovation to enhance its z Systems and Power product lines, as well as adapt to high-growth areas such as IoT, analytics and cognitive computing. Further, the announcement illustrates IBM’s efforts to increase licensing revenue streams from GlobalFoundries and other manufacturers in an effort to offset continued revenue contraction within its Systems Hardware business.