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IBM, Lenovo in Talks over Server Unit Sale

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Reportedly, International Business Machines Corp. (IBM - Free Report) and Lenovo have restarted negotiations toward the divestiture of former’s low-end server unit to the China-based group. The sale will help IBM to focus more on its fast-growing software and services business.

For some time, Lenovo has been showing keen interest in acquiring the server unit. However, differences over valuation primarily led to last year’s disagreement. At that time, IBM had quoted approximately $4.0 billion to $6.0 billion for the unit, while Lenovo was unwilling to spend more than $2.5 billion.

Although valuation remains a concern, we believe the deal offers a win-win situation to both the companies. The sale of the x86 servers will help IBM to shift from a low-margin hardware business to higher-margin software and services, which will improve its profitability, going forward.

Lenovo will be able to expand its footprint beyond a declining personal computer market. The company is aggressively pushing itself into the fast growing mobile devices and data storage market. The acquisition will not only boost its presence in these markets but also provide it a recurring revenue stream over the long term.      

However, Lenovo is not the only suitor for IBM’s X86 server business. Reportedly, Dell, the third-largest server vendor after IBM and Hewlett-Packard (HPQ - Free Report) in terms of revenues, is also eyeing the unit, in order to reduce its exposure to the PC market.

In such a scenario, we believe multiple bids for the server unit will increase the chances of a favorable deal for IBM. Moreover, a deal with U.S.-based Dell instead of Lenovo, will help IBM avoid scrutiny from foreign investment regulating authorities.

IBM is set to report fourth-quarter results on Jan 21, 2014. The results will primarily depend on the performance of the software segment, while any improvement in the hardware sales will be encouraging.

We believe that software sales will be driven by IBM’s aggressive expansion into the cloud. The company’s recently announced plans to invest $1.2 billion to build 15 data centers and continuing share buyback program are major positives.

However, sluggish enterprise IT spending and intensifying competition from the likes of Oracle (ORCL - Free Report) and SAP AG (SAP - Free Report) in the software business are headwinds.

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

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