3 Stocks to Watch in Servers

By Markets Fool.com

The $50 billion global server market is in a state of transition. Big cloud computing companies are increasingly turning to both white box systems from original design manufacturers and custom-built systems, cutting out the major server vendors altogether. In 2014, the global server market grew by just 2.3%, but revenue from original design manufacturers grew by 40%, and revenue from vendors outside of the top five grew by 26.3%.

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With all of the changes occurring in this industry, International Business Machines , Lenovo , and Cisco are three server stocks investors should keep an eye on.

International Business Machines
IBM server revenue plummeted during 2014, declining nearly 27%, thanks largely to the sale of its x86 server business to Lenovo. IBM is now left with only Power systems and mainframes, leaving it to compete mainly in the high-end segment.

The mainframe business remains strong, and a recent refresh of its mainframe product line lifted sales by over 100% during the most recent quarter. IBM completely dominates the market for mainframes, and while this represents a small part of the total server market, the mainframe business has proven to be incredibly resilient over the years.

IBM Power servers, on the other hand, have been losing the battle against servers built with Intelx86 chips -- Big Blue is now fighting back. The company is part of the OpenPOWER foundation, which seeks to build an ecosystem around the Power architecture by opening it up to partners. While Power servers could only be purchased directly from IBM in the past, the company is now allowing third parties to manufacture Power-based systems.

Companies like Google and NVIDIA, along with over 100 others, are on board, and the first non-IBM Power servers are expected to launch sometime this year in China. This has the potential to disrupt the market if these Power servers are priced competitively compared to Intel-based systems.

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Lenovo
Lenovo bought the IBM PC business in 2004, and over the past decade, the company has grown into the largest PC vendor in the world. It is now looking to do the same in the server industry, snapping up IBM's x86 server business last year.

Lenovo server sales put it well out of the top five in 2013, but in the fourth quarter of 2014, including the effects of the acquisition, Lenovo rose to the No. 4 spot, recording $1.1 billion in sales. The company knocked Oracle completely off the list, with its market share reaching 7.6%.

Lenovo has big plans for its enterprise segment. The company expects to generate $5 billion in annual enterprise sales within one year after closing the IBM deal, and it expects to boost profitability as well. With margins in the PC business extremely low, a higher-margin enterprise business could do wonders for Lenovo's bottom line.

The company is facing some challenges, however. Lenovo inherited former IBM x86 customers in the deal, and some of them are not happy that their server vendor is now based in China. The U.S. Navy, which uses IBM servers in the Aegis Combat System, is working with the system vendor, Lockheed Martin, to replace the servers due to security concerns.

Despite these issues, with China being a major server market, Lenovo has the opportunity to continue to grow its enterprise business going forward, potentially stealing away market share from market leaders HP and Dell. If its rise in the PC market is any indication, Lenovo knows how to disrupt the status quo.

Cisco
Cisco, known for its networking switches and routers, came out of nowhere a few years ago with its Unified Computing System, or UCS, servers. Cisco UCS servers include both computing hardware and networking hardware and software, providing an integrated solution meant to lower the total cost of ownership for its clients.

In the fourth quarter of 2014, Cisco managed to take the No. 5 spot in the global market, selling about $770 million worth of servers. As of the most recent quarter, Cisco UCS servers have reached a $3 billion annual run rate, with 85% of Fortune 500 companies counted as customers.

Cisco now leads the x86 blade server market in the United States, and it is second worldwide, an impressive accomplishment given that UCS was first launched in 2009. Cisco server revenue is growing far faster than the market as a whole, up 19.1% year-over-year during the fourth quarter of 2014, according to IDC, and up 21% year-over-year during its most recently reported quarter.

It is difficult to say how much market share Cisco will ultimately be able to win, but its success in the server market shows that even big, lumbering companies can disrupt markets.

The article 3 Stocks to Watch in Servers originally appeared on Fool.com.

Timothy Green owns shares of Cisco Systems, International Business Machines, and Nvidia. The Motley Fool recommends Apple, Cisco Systems, Google (A shares), Google (C shares), Intel, and Nvidia. The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), International Business Machines, and Oracle. Try any of our Foolish newsletter services free for 30 days.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.