Shabbir's  Instablog

While Intel and AMD continue to compete fiercely in the server processor market, server vendors continue to operate in a sluggish demand environment with a yoy revenue decline in the range of 20-25%. Server & storage revenue from top 4 vendors (namely IBM, HP, Dell, and Java) declined 25% yoy to ~$10.02 B. These were the largest yoy decline in the last five years in the server industry and continued the trend of declining revenue that started in 3QCY08 (Exhibit 1 shows the historical revenue performance and growth rate). Below we take a look at the standalone performance of each company.

Exhibit 1: Total server & storage revenue of HP, IBM, Dell and Sun (Period: 1QCY06-1QCY09)

 Exhibit 1 continued…Period: 1QCY04-4QCY06

Source: Company documents and Gridstone Research

IBM's S&TG segment revenue declined 18% yoy in constant currency along with a 300 bps decline in gross margin to 34%. The only bright spot in IBM’s server portfolio was the converged System p products whose revenue declined 1.8%; however, increased 5% yoy in constant currency. However, revenue from system x and z series server declined 28% and 19%, respectively (Exhibit 2). Though, the unit shipment for IBM declined 23.5% yoy to ~231 K (Exhibit 4) decline in server revenue was arrested slightly by a better product mix in favor of p series (IBM discontinued its reporting of growth rate of iSeries server revenue in 1QCY09).

Exhibit 2: Historical performance IBM’s server product portfolio

Source: Company documents and Gridstone Research

Enterprise storage and server revenue for the worldwide market leader HP declined by 28% yoy to $3.46 B. Even though HP gained market share in x86 servers and maintained its leadership position, both Industry Standard and Business Critical systems witnessed decline of 29% to $1,988 M and $650 M, respectively. Overall, unit volume for HP declined 22.3% yoy in 1QCY09 (Exhibit 4). The decline was accompanied by both unit volume and average unit price decline. Industry standard servers include primarily entry-level and mid-range ProLiant servers, which run primarily on Windows, Linux and Novell operating systems. Business critical systems include Itanium based Integrity servers running on the HP-UX, Windows, Linux, OpenVMS and Non-Stop operating systems.

Dell’s 1QCY09 server and storage revenue declined 23% yoy (inclusive of networking revenue). In servers and networking, the decline was led by a 28% yoy decline in unit shipments; however, decline was partially mitigated by a 4% yoy increase in ASP in servers.

Sun Microsystems 1QCY09 worldwide server and storage revenue declined 24% yoy primarily led by 28.5% decline in unit shipments partially offset by increase in prices and increased sales of CMT volume servers.

While the overall results suggest that the demand environment continued to remain weak due to ongoing recession, all the four companies witnesses some growth in their new product lines. For example, IBM in system P, Sun in CMT, etc. Therefore, we can also say that the current revenue downturn in servers & storage may be due to two factors: economic slowdown and product life cycle which involves declining revenues of legacy products. With the economic conditions and demand stabilizing it will be interesting to see how the other factor i.e phasing out of old products plays in the 2^nd quarter of CY09. We can have a better understanding of this when IBM comes out with its result on 16^th July.

Exhibit 3: Summary of Revenue performance of top 4 server vendors

Source: Company documents & Gridstone Research

Exhibit 4: Worldwide: Server Vendor Shipment Estimates, 1Q09 (Units)

Source: Gartner (June 2009)

Disclosures: No positions.

With over 85% penetration and slowing US economy Wireless market was not expected to post any significant subscriber gains in 1Q CY09 and as per expectations subscriber additions were weakest in the last 3 years. Service providers in 1Q added just over 3 M subscribers compared with ~4.9 M net additions in 1Q CY08 (Exhibit 1).

Exhibit 1: Slowing subscriber additions 

Source: Gridstone Research

With these net additions, the overall wireless subscriber base reached 264.67 M with top 4 service providers (VZ, T, S and DT) securing ~93% market share.

Exhibit 2: Market share based on Customer base

Source: Company Reports and Gridstone Research

While the overall subscriber additions were impacted by the worsening economic conditions, standout performance came from LEAP and PCS as both accounted for a yoy increase in subscriber additions to 684 and 493 K. Another surprise was the decrease in subscriber loss at S (3^rd largest service provide) to 182 K compared with 1,087 K in 1Q CY08; the improvement was primarily due to improvement in quality initiatives.

Exhibit 3: Subscriber addition by service provider

Source: Company reports and Gridstone Research

With the lower additions, service providers took steps to keep the existing subscriber base intact and to maintain the revenue and profit levels by improving quality and handset offerings. This effort resulted in decline churn rate at all major service providers except for VZ who posted a 10 bps qoq increase in churn rate to 1.5%.

Exhibit 4: USM jointly with VZ has the lowest industry churn 
 

Source: Company reports and Gridstone Research

Consistent with previous quarters, ARPU continued to decline in 1Q09 despite a double digit increase in data ARPU by most service providers.

Exhibit 5: Consistent decline in ARPU despite increase in data revenue

Source: Company reports and Gridstone Research

Conclusion: With declining net additions and ARPU service providers have started taking a look at alternative sources of revenue generation. T and VZ spotted this earlier and started with their fiber cable offerings of broadband and satellite TV services; however, these services have not generated substantial returns till date. Another scenario that likely emerges is further consolidation with VZ taking over AT purely for subscriber numbers it remains to be seen that regional players like USM, LEAP and PCS will be able to work independently or will be gobbled up by any big service provider.

Disclosures: No positions in VZ, T, S, PCS, USM, LEAP, DT, CYCL or ALSK