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Should IBM be in the chip business?

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CIOL Bureau
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NEW YORK: IBM's new $3 billion microchip factory was supposed to bring the company efficiency and profit. Instead, it is giving the technology leader a headache.

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Demonstrating the risk of huge investments in advanced chip-making tools, IBM cited production problems at the gleaming chip plant in East Fishkill, New York, as a reason why its microchip business would lose money this year.

IBM shares fell almost 5 percent Thursday, in part because of that disappointing disclosure in IBM's second-quarter earnings released on Wednesday evening. IBM met analyst profit expectations.

In contrast to IBM, advanced chip equipment is easing the way for Intel Corp. , which this week raised its profit margin target for the year in part because of tools that produce chips with finer features on larger discs of silicon.

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The disappointing start at the IBM plant is likely to reignite debate about whether IBM should be in the business of making semiconductors for other companies, Sanford C. Bernstein analyst Toni Sacconaghi said in a research note on Thursday.

"The disappointment in microelectronics is a major executional blunder, and we can't help wonder why IBM did not have a better read on what its customers plans were, or why IBM has experienced a sudden contraction in orders while some other semi players have not," Sacconaghi wrote. He rates the stock "market perform."

IBM's business of producing specialized chips for different customers made efficiency a bigger problem than at Intel, which produces one type of product at its advanced plants, said Chris Danely, an analyst with J.P. Morgan.

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"If it's your first time doing something, whether it's making a semiconductor or baking a cake, after the 10th time it's going to be a lot easier," Danely said.

IBM announced plans for a $5 billion expansion in its chip making efforts just as a global downturn in semiconductors began in October 2000. As the downturn took hold, the division began losing money and IBM closed down some older chip-making capacity.

The company stuck by plans for the plant, setting itself up as a competitor to the world's largest contract microchip maker, Taiwan Semiconductor Manufacturing Co. <2330.TW>. It began production this year.

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IBM's chip business lost $110 million in the second quarter and is now expected to lose money for the year, in contrast to earlier company predictions for it to add to profits.

Production problems and plant underutilization took away $45 million from IBM's overall profit, Chief Financial Officer John Joyce said on a conference call after IBM's earnings report on Wednesday.

Joyce said he did not expect to see revenue improve in the division until the fourth quarter. The customers who had signed deals to buy specially designed chips from IBM are not ordering "at a rate and pace" that IBM had assumed, he said.

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So far this year, IBM has said, it will make specialized chips for Analog Devices Inc., Nvidia Corp. and Xilinx Inc. . It is also making PowerPC chips for Apple Computer Inc.'s PowerMac G5 computer, which is due to ship in August.

The company isn't losing market share to competitors, Joyce said, describing the bad performance as "somewhat of an economic issue."

"We'd like to see the semiconductor industry begin to pick up and we think if the economy begins to pick up, we will benefit from that," Joyce said.

IBM's shares lost $4.06, or 4.7 percent, to $82.68 midday Thursday on the New York Stock Exchange.

© Reuters

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