IBM: Financially Sound and Well-Poised for Cognos Acquisition

Analysis of News Events
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3Q07: Mixed Results from Systems and Technology Group

Overall, IBM performed well in the third quarter, reporting in its 3Q07 Quarterly Earnings Report diluted earnings of $1.68 per share (up 16 percent). IBM Global Business Services revenues were up 16 percent, and IBM Global Technology Services revenues were up 13 percent. Revenues from Software Group were $4.7 billion, up 7 percent (3 percent, adjusting for currency) compared with 3Q06. However, reported revenues for the Systems and Technology Group (STG) totaled $4.9 billion for the quarter, down 10 percent (13 percent, adjusting for currency) compared to 3Q06.

IBM's STG reported revenues from System p UNIX server products increased 6 percent compared with 3Q06 and System x server revenues increased 6 percent compared with 3Q06.

System z and System i, however, did not fare as well. Revenues from System z server products decreased 31 percent compared with 3Q06 and revenues from System i servers decreased 21 percent compared with 3Q06. Furthermore, revenues from System Storage increased only 1 percent and revenues from Microelectronics decreased 15 percent.

So what does all this mean?

The More Things Change, the More They Stay the Same

In his prepared remarks to the analyst community, Mark Loughridge, IBM Senior Vice President and Chief Financial Officer, indicated that IBM saw sector growth in the public sector with "...solid growth in government, healthcare, and education." However, Loughridge pointed out that the "...weakest sector performance was in the financial services sector ..." and "...more pronounced in the US." This, he averred, had a negative impact on System z. Also, many deals slated to close in the third quarter have been deferred, with expectations that they will close in the fourth quarter.

In the humble opinion of this analyst, I think it is obvious that in recent years there has been a growing trend in the marketplace toward UNIX and Intel-based systems. Most higher-end mid-sized companies and virtually all large companies run heterogeneous IT shops and usually have a mix of UNIX, Intel-based, and mainframe servers—not to mention a mixed bag of application, middleware, and hardware vendors.

IBM has worked diligently to build up its System x franchise, and it shows in increased mind and market share. UNIX and Intel-based systems as well as blades, which grew 8 percent compared with 3Q06, are the jewels in the proverbial crown of STG. Why? Because customers understand UNIX and Intel-based systems and blades.

While the anomalies in the System z revenue were addressed, IBM remained somewhat quiet on the System i front. The fact remains that the perception of System i as legacy and outmoded still persists despite efforts by STG to change that perception. Moreover, part of the value proposition of System i is its staying power. System i is like Stride Gum—"the ridiculously long-lasting gum"—which, as the ad laments, still has consumers chewing their first piece. As with Stride, System i customers' wont is to keep chewing or at least holding onto the same server forever, loathe to purchase additional footprints. System i needs less maintenance than other servers, and you don't have to buy another System i whenever you implement a new application. Those stories about immured AS/400s that keep on working are not fiction.

I tend to think the following are some pretty solid reasons for System i revenues being down for the quarter:

  • Product transition—Customers are evaluating POWER6 technology. Customers on the leading edge are also looking at the migration effort involved in moving to i5/OS V6R1 and the concomitant program conversion. While IBM, on its i5/OS V6R1 program conversion Web page, indicates that this conversion will be simpler than previous ones (i.e., when moving from System/38 to AS/400 V1R1M0 in 1988 and when moving to AS/400 V3R6M0 in 1995), program conversion is still daunting, especially when the business—and your job—are on the line.
  • It's always been this way—System i's existing, and even prospective, customers tend to be cautious, especially at this time of the year. Demand is seasonal, and it is a function of product announcements as well as those ever-anticipated year-end deals. Budgets also tend to be spent, and/or customers are preoccupied with next year's budgets.
  • Re-tooling—As IBM is well aware, customers that continue to run legacy and/or homegrown applications on earlier versions of System i servers are either loathe to change or may be looking at ripping and replacing existing systems. Small and mid-sized business are now savvy enough to know that decisions regarding applications must be made at the business level, and that translates into applications that support the business, regardless on what servers they run. And even though IBM has been successful with its System i Vertical Industry Program (VIP), which has generated $52 million in customer purchases—$30 million of which are first-time System i customers—the program is still gaining momentum. The challenge for IBM is to grow this program beyond the 160 or so sub-industries and continue to inculcate the value of applications delivered on System i to customers and Business Partners. (Note: I was encouraged to see that Marc Dupaquier, General Manager of IBM Business Systems believes that "[t]he success of the program is predicated on IBM’s understanding that small and medium businesses identify themselves in the context of their industry and therefore seek industry-specific expertise.")

Is Business Intelligence an Oxymoron?

I have been writing about business intelligence (BI) now for over 10 years. And for those 10 years plus, the nirvana of bona fide business intelligence—the ability to transform data into actionable and even predictive decision-making information—is still elusive. Sometimes I think that spinning hay into gold would be easier.

This is why I applaud IBM's move to acquire Cognos. This is a brilliant and competitive gambit, as it follows SAP AG's recent announcement to link-up with Business Objects SA, for which Reuters reported that SAP is set to pay $6.84 billion. And it also follows on the heels of Oracle Corp.'s recent purchase of Hyperion Solutions for $3.3 billion, which is the company's first ingress into the BI market since its purchase of Siebel.

Since the IBM announcement, pundits have opined about the pros and cons of the Cognos proposed acquisition. In its November 12, 2007, press release, IBM says it is acquiring Canada-based Cognos, which its 23rd acquisition in an already impressive portfolio of products designed to enhance its Information on Demand strategy, which was announced on February 16, 2006.

IBM has been a bellwether player in the BI space, providing business intelligence solutions for decades. As Steve Mills, Senior Vice President and Group Executive, IBM Software Group, pointed out, "Customers are demanding complete solutions, not piece parts..." Cognos is a stable company with solid technology and has been a premiere IBM Business Partner for many years.

Bottom line: Customers don't want to integrate multiple solutions. The industry has shifted (paradigmatically, of course) from the halcyon days of boutique applications that came with huge price tags for the services involved in integrating them into the existing application architecture. I think Mills is on target. Customers want complete and interoperable solutions so that they can cease having to assemble the puzzle and, instead, enjoy the fruits of big integrated picture.