Parsing IBM's weak hardware sales

IBM reported a solid third quarter, but there are some real worries about Big Blue's weak hardware results.IBM's quarter--as usual--was a tale of software and services.
Written by Larry Dignan, Contributor

IBM reported a solid third quarter, but there are some real worries about Big Blue's weak hardware results.

IBM's quarter--as usual--was a tale of software and services. That tandem allowed the company to report earnings of $1.68 a share on revenue of $24.1 billion, just ahead of Wall Street estimates.

But IBM's earnings conference call (transcript) had a heavy dose of hardware worries. Systems and technology group revenue was down 10 percent to $4.9 billion as sales of System x and System z (down 31 percent) fell short. Hardware revenue was more than $600 million short of Cowen and Co. analyst Louis Miscioscia's estimates.

So what went wrong?

There are two confirmed moving parts and another that is speculation on my part. First, IBM CFO Mark Loughridge said that a slowdown in demand from financial services firms crimped sales. Bottom line: Amid a credit crunch financial services firms weren't thinking much about buying mainframes. IBM's admission is notable since few vendors have seen problems with financial services companies. Tibco blamed financial services customers for a weak quarter, but then executives too it back and blamed poor execution.

"The weakest sector performance was in the financial services sector. By geography, the impact was most pronounced in the U.S. By brand, the largest impact was in System z, facing a difficult compare. Outside of this, financial services sector revenue performed in a more typical range within financial services sector," said Loughridge. "The U.S. was the major geography affected from a brand standpoint. zSeries was the major brand affected. I think that's logical, zSeries has about 50% of their business in (the financial services sector), so I don't think that is a surprise, given the sector dynamics."

The second item at work here is that customers are waiting for quad-core servers and evaluating their options, said Loughridge, who noted that much of IBM's hardware line will get quad-core chips from Intel and AMD in the fourth quarter.

And third, I wonder if virtualization plays a role here. Are server and mainframes taking a hit as IT managers cram more software on fewer boxes courtesy of virtualization? We know the story from vendors--virtualization boosts hardware sales as buyers acquire more richly configured boxes--but I don't buy it in the long run.

On the virtualization front, it's too early to make any big declarations about the impact on hardware sales. For now, the hardware sales at IBM are worth monitoring.

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