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Right Direction, But Tougher Road Ahead for IBM

Big Blue’s shedding of businesses with low returns on capital is a good idea, but weaker demand for the firm’s core products is likely to weigh.


Today,  IBM (IBM) announced an agreement to sell its chip manufacturing business to GlobalFoundries. It also lowered its 2014 and 2015 financial outlook. Strategically, IBM continues to move in the right direction, in our opinion, as it decreases exposure to businesses with low returns on capital. However, as the firm publicly acknowledges weaker-than-expected demand for its products and services, we are likely to reduce our fair value estimate by a modest amount. We are placing IBM under review while we adjust our model.

The divestiture of the microelectronics business fits well into IBM's ongoing evolution. Management continues to stress movement away from low-margin businesses, and the disposal of the microelectronics business will take a capital-intensive business that was responsible for roughly $700 million in pretax losses in 2013 off the books. IBM will still invest research and development capital of roughly $3 billion over the next five years in the semiconductor business (as a fabless producer), with GlobalFoundries serving as its exclusive server processor manufacturer for the next 10 years under the terms of the agreement. The deal is expected to close in 2015 and should not face much scrutiny from regulators.

Rick Summer does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.