In-Depth

Will EC12 Be a Sales Behemoth?

Although the zEnterprise EC12 probably won't match the record-breaking performance of its predecessor, it should provide a big boost to Big Blue's bottom line.

We know it's scalable, available, and brawny, but what kind of sales behemoth will IBM Corp.'s new zEnterprise EC12 mainframe turn out to be?

We'll have to wait until January to find out. IBM's lackluster Q3 performance wasn't greatly impacted by EC12, which Big Blue announced on August 30th, just 32 days before the end of its fiscal third quarter. By contrast, the zEnterprise 196, which preceded the EC12 by just over two years, was announced in late July 2010 and began shipping in September, helping to lift IBM's Q3 2010 earnings. This time, Big Blue received no such Big Iron buoying.

That said, IBM officials seem to expect one in Q4. "As we move into the fourth quarter we have new product introductions in our Systems portfolio not just in System z but also in Power [7+] and storage," said IBM CFO Mark Loughridge, during his Q3 earnings call with analysts.

During the Q&A portion of the call, Loughridge both acknowledged the reality of tough market conditions -- e.g., a slow economic recovery compounded by the looming threat of a January 1st 2013 "fiscal cliff" -- and doubled-down on the bottom-line benefits of the new EC12, predicting double-digit growth.

"Clearly the big announcement for the quarter is the new zSeries, and as we look at the new zSeries, now [with Q4] we have a full quarter of opportunity," said Loughridge.

"In the third quarter, we're really only shipping the new z for about 11 days in the very back end of the quarter and in front of that ... ship date, we only had about three weeks of selling time, so now is the opportunity for [a] full quarter's work," he told analysts, adding: "As I look at it, I think they [i.e., IBM's Systems and Technology Group] have a very strong case on a hardware basis for the new z platform to generate 20 percent to 30 percent growth."

Appetite for New Iron: A Brief History

How does Loughridge's prediction of 20 to 30 percent growth compare with the historical demand for new mainframe releases?

It's modest, but probably realistic, given Big Iron buying trends.

Let's start with recent history first. In Q4 of 2010, the first full quarter during which IBM's zEnterprise 196 was available, mainframe revenues surged by 70 percent.

That's more than twice what Loughridge predicted for the EC12. At the same time, the fourth quarter of 2010 was literally historic, at least in mainframe annals: according to International Data Corp. (IDC), for example, it marked the biggest-ever surge in demand for Big Iron.

Through the first nine months of 2011, IBM averaged about $1 billion in mainframe sales each quarter; during Q4 of 2010, it moved $1.7 billion in new zEnterprise hardware systems.

In other words, there was plenty of pent-up demand.

There was plenty of pent-up demand because IBM's previous mainframe system refresh, the z10, had been released in late February of 2008 -- nearly two and a half years prior to the z196. There was plenty of pent-up demand because there'd been plenty of deferred purchasing. Thanks to the brutal economic environment, mainframe sales suffered through most of 2009. By early 2010, enterprises again had money to spend -- server sales rebounded, for example -- but Big Iron shops weren't yet buying. Instead, they were waiting for Big Blue's next-gen mainframe, which had been promised for late 2010.

Once it appeared, enterprises snapped it up at a record-breaking clip.

The sales performance of the z10, which was released in late February of 2008, is probably more instructive. Like the z196, it shipped about 2 1/2 years after Big Blue's z9 mainframe, which was released in September of 2005, so there should have been plenty of pent-up demand for z10 -- and there was. On a percentage basis, however, z10's surge came in at less than half that of z196: in his Q2, 2008 earnings call, for example, Loughridge reported that System z revenues were up by an impressive 32 percent, year-over-year.

Impressive, yes, but 32 percent is a far cry from 70 percent. That being said, the sales outlook for the z10 was by no means routine, either.

The z10 debuted just two weeks before the implosion of investment banking giant Bear Stearns, an event at the beginning of a global financial crisis. Not only did the z10 debut among uncertainty, but its year-over-year sales were bound to suffer by virtue of comparison with those of the second quarter of 2007, when U.S. GDP was still growing at a scorching 3.9 percent rate. (In spite of incipient uncertainty, GDP growth rallied to 2.8 percent in Q2 of 2008 -- only to tank, decisively, in Q3 and beyond.)

Besides, the z10 was a stellar performer, revenue-wise, relative to its predecessor, the z9, which posted a meager 5 percent sales increase, year-over-year.

In retrospect, however, the z9's out-of-the-gate performance was something of an outlier: sales of its predecessor, IBM's z990 mainframe -- which was released in June of 2003 -- surged by 30 percent during the first full quarter of its availability.

System z9's performance seems anomalous in this context.

If we disregard the highest (70 percent) and the lowest (5 percent) results in our sample, we're left with 30 percent and 32 percent growth rates for Systems z990 and z9, respectively.

That's at the high end of the range which Loughridge set, but given history, Loughridge might be setting the bar somewhat low. That's one reason IBM seems confident it will be able to meet its aggressive earnings per share (EPS) goals for 2012 and beyond.

"I think North America needs to capitalize on the great hardware product lineup we have for the fourth quarter with the new z, the new p, and storage to drive transactional sales performance in the fourth quarter," he concluded. "Based on this, we are confident in our plans to achieve at least $15.10 of operating EPS for the year. That's up 12 percent from last year."

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