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IBM to Pay $1.5B to Drop Chip Manufacturing Unit

International Business Machines Corp. (IBM) recently agreed to pay a sum of $1.5 billion to GlobalFoundries in order to shed its loss making chip manufacturing unit. This sum will be paid by IBM over a period of three years.

IBM will receive working capital worth $200 million, thus taking the net value of the deal to $1.3 billion. Reportedly, per the deal, GlobalFoundries will take over IBM’s main manufacturing plant located in FishKill, New York as well as a smaller plant based in Vermont.

GlobalFoundries is a Santa Clara, CA-based semiconductor foundry created by the divestiture of the manufacturing arm of Advanced Micro Devices (AMD) on Mar 2, 2009. The Emirate of Abu Dhabi is the owner of the company through its subsidiary Advanced Technology Investment Company (:ATIC).

Per the joint venture deal struck between the two companies, GlobalFoundries would make chips for IBM for a period of ten years, while IBM would retain some or all of the patents and intellectual property.

IBM had been looking for ways to divest the business since 2013. The company had hired Goldman Sachs (GS) for this purpose. However, IBM eventually backed away from the idea of divestiture due to unavailability of buyers and instead sought a joint venture.

Earlier in 2014, IBM had agreed to form a joint venture with GlobalFoundries. However, no agreement could be reached at that time owing to disputes over financial matters.

IBM’s growing challenges in the hardware segment improved GlobalFoundries’ bargaining power. In the second quarter of fiscal 2014, hardware revenues plummeted 11.4% on a year over year basis. Management noted that the company faced headwinds related to power, storage and System X in the hardware segment, which negatively impacted results.

We believe that the sale of the loss-making business will boost IBM’s hardware margins, going forward. Moreover, it will help the company to focus more on its fast growing software and services business. The divestiture would reduce significant competition for IBM in the chip-manufacturing market.

Nevertheless, sluggish enterprise IT spending and intensifying competition from the likes of Oracle (ORCL) and SAP AG (SAP) in the software business will continue to pose concerns for IBM in the near term.

Currently, IBM has a Zacks Rank #4 (Sell).

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