IBM's Server Sale Would Be a Smart Move

NEW YORK (TheStreet) -- Rumors are swirling that IBM (IBM) is looking to sell off its low-end server business as the tech giant continues to target higher-margin areas.

Citing people familiar with the matter, The Wall Street Journal reported that IBM is trying to sell its x86 server operation, with Dell looking at the business. Another source said that Chinese tech heavyweight Lenovo could be a potential purchaser.

An IBM spokesman told TheStreet the company doesn't comment on rumor and speculation. Lenovo also declined to comment. Dell has not yet responded to TheStreet's request for comment.

Nonetheless, a sale of the IBM's server business could make sense for the Armonk, N.Y.-based firm, which has spent recent years shifting its corporate focus away from hardware onto high-margin software and services.

IBM's lower-end commodity hardware, in particular, has been feeling the strain. During the company's fiscal third-quarter, for example, revenue from System x x86 servers fell 18% compared to the same period last year. In contrast, the company's high-end System z mainframe sales increased 6%.

The weakness in System x revenue was also evident in the prior quarters. During its fiscal first quarter, IBM's x86 server revenue declined 9% year-over-year while its mainframe business grew 7%. In the second quarter, System x was down 11% with System z up 10%.

Getting rid of commodity businesses is certainly in keeping with IBM's recent philosophy, as evidenced by the 2005 sale of its PC business to Lenovo and the divestiture of its Printing Systems division two years later.

"Over the years, it has been very clear to us that IBM has been divesting commodity parts of the portfolio to focus on higher value-add areas such as software, services, or next-generation computing, such as cognitive computing -- for example, the Watson supercomputer," said Brian White, an analyst at Cantor Fitzgerald.

Earlier this month IBM announced its plan to set up a New York City-based business unit devoted to Watson. The company will also invest more than $1 billion in the Watson Group, focused on R&D and bringing cloud-based applications and services to market.

Speaking at a glitzy New York City event to unveil the business unit, IBM CEO Ginni Rometty explained that Watson heralded a third "cognitive era" of computing when it was first launched in 2011. "It's a new species -- it is taught, not programmed," she said. "It learns from experience and interaction."

At its investor briefing last year, IBM increased its 2015 revenue target for analytics and big data to $20 billion from $16 billion, highlighting the potential for technologies such as Watson. Back in 2010, IBM had set an initial goal of $10 billion by 2015.

Underlining IBM's desire to tap new software and service dollars, just a week after its latest Watson news, Big Blue announced a $1.2 billion global cloud investment.

IBM's System x sales should also be viewed within the context of its broader business. The company's total revenue in fiscal 2012 was $104.5 billion, with Global Technology Services and Global Business Services bringing in, respectively, $40.2 billion and $18.6 billion. Software revenue was $25.4 billion, while the Systems & Technology group brought in sales of $17.7 billion. A source familiar with the situation told TheStreet that, within the Systems & Technology group, IBM's x86 server business had revenue of less than $5 billion in 2012.

IBM reports its fiscal fourth-quarter results after market close on Tuesday. Analysts surveyed by Thomson Reuters expect the hardware and software giant to post earnings of $5.99 and sales of $28.25 billion.

During the third quarter IBM beat Wall Street's earnings expectations but missed on the top line, weighed down by currency issues and weakness in key growth markets.

"We expect all segments to rise -- led by strength in software," wrote Cantor Fitzgerald's White, in a note released on Tuesday. "Recall, IBM experienced weakness in China and other developing markets in 3Q:13, a trend we expect to continue through the first half of 2014."

Despite this trend, White expects the company's software sales to rise 34% sequentially, above seasonal levels. Services should improve over 3% quarter-on-quarter, he added, in line with seasonality. The analyst expects IBM's System and Technology Group sales to increase 25% over the same period, well below historical averages, albeit with upside potential.

IBM shares dipped 0.96% to $188.27 in early afternoon trading on Tuesday.

--Written by James Rogers in New York

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