International Business Machines Corp. (IBM) finally agreed to sell its low end X86 server business to Chinese PC maker Lenovo for $2.30 billion. Of the total deal price, nearly $2.07 billion will be paid in cash and the rest in Lenovo stock.

Lenovo had been in talks with IBM over the proposed sale for quite some time. Last year, the deal did not materialize owing to differences on valuation. 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.

However, IBM’s growing challenges in the hardware segment improved Lenovo’s bargaining power. In the recently concluded fourth quarter, IBM’s hardware revenues declined 26.1% from the year-ago quarter.

Management noted that the company is facing headwinds related to Power, storage and X86 server unit in the hardware segment, which negatively impacted results.

Although the server unit attracted a number of other suitors such as Dell, Fujitsu and Hewlett-Packard (HPQ), we believe that IBM’s unimpressive result compelled it to divest the unit in a hurry to avoid further decline in valuation.

Nevertheless, we believe that the sale of the low-margin 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 reduces significant competition for IBM.

Although IBM’s fourth-quarter results disappointed, we believe that strategic acquisitions, divestiture of non-core businesses, investments in fast growing markets such as cloud computing and analytics business will boost 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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