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IBM to Sell Chip-Manufacturing Biz to Globalfoundries

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Reportedly, IBM Corp. (IBM) has agreed to sell its loss-making chip manufacturing unit to Globalfoundries. Although the financial details of the deal are not available, it is rumored that the sale-price is approximately $1.0 billion -- much lower than IBM’s initial expectation of $2.0 billion.

Although the server unit attracted a number of other suitors such as Intel (INTC) and Taiwan Semiconductor Manufacturing (TSM), we believe that IBM’s unimpressive results compelled it to divest the unit in a hurry to avoid further decline in valuation.

IBM had been looking for ways to divest the business for quite some time. It had hired Goldman Sachs for this purpose. However, the company eventually backed away from the idea of divestiture and instead sought for a joint venture.

IBM believed that a joint venture will enable the company to have control over the design and intellectual property of the chips. Eventually, IBM entered into a joint venture with Globalfoundries in 2012.

Currently, Globalfoundries seems more interested in acquiring IBM’s intellectual property (IP) and technological knowhow rather than its manufacturing capability since the latter is more than 10 years old and hence, has undergone considerable depreciation. Globalfoundries, which already has a technology joint development project with IBM, will continue to act as the supplier for IBM’s microprocessors.

IBM’s growing challenges in the hardware segment improved Globalfoundries’ bargaining power. In the first quarter, IBM’s hardware revenues declined 23.0% from the year-ago quarter. Management noted that the company faced headwinds related to power, storage and System X in the hardware segment, which negatively impacted results.

Nevertheless, we believe that the sale of the loss-making business will boost IBM’s profitability, going forward. Moreover, it will help the company to focus more on its fast growing software and services business. We also believe that the divestiture would reduce significant competition for IBM.

We believe that strategic acquisitions, divestiture of non-core businesses, investments in fast growing markets such as cloud computing and analytics business will boost the top line in 2014.

Moreover, aggressive share buyback will boost profitability. However, sluggish enterprise IT spending and intensifying competition from the likes of Oracle (ORCL) and SAP AG (SAP) in the software business are headwinds in the near term.

Currently, IBM has a Zacks Rank #3 (Hold).

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