UPDATE 3-IBM, Sun Micro talks collapse over price -source

* Talks collapse over price

* IBM's offer was $9.40 or lower

* Unclear if talks will resume (Adds background on talks)

By Ritsuko Ando

NEW YORK, April 5 (Reuters) - IBM's (IBM.N) talks to acquire smaller computer and software rival Sun Microsystems Inc (JAVA.O) broke down on Sunday after Sun rejected IBM's $7 billion offer, a source with knowledge of the matter said.

The collapse of negotiations, if final, is likely to hurt Sun's shares as a buyout was seen as a means of survival for the once-storied Silicon Valley company, which has been losing market share. A deal would also have helped IBM compete more effectively against rivals such as Hewlett-Packard Co (HPQ.N).

The source, who was not authorized to speak publicly about the matter, said Sun was unhappy with International Business Machines Corp's offer of $9.40 per share or below, and that it was unclear if talks would resume.

The bid represented a premium of up to 89 percent on Sun's shares before deal talks were first reported last month.

"Sun is now sort of damaged goods," said Peter Falvey, a technology banker at Revolution Partners. "If IBM got under the covers and didn't like what they saw, then what does that mean for other potential buyers?"

An IBM spokesman declined to comment, while Sun officials did not return calls.

Sources told Reuters last month that IBM was in exclusive talks to buy Sun and had proceeded to the due diligence stage. One source had said on Saturday that IBM lowered its offer price for Sun to $9.50 a share from $9.55 a share and that a deal may be announced this week.

Sun shares had risen to $8.49 on Friday, from $4.97 on March 17, a day before talks between the two technology companies were first reported. The Wall Street Journal had previously said IBM's original bid was $10-$11 a share.

DEAL FACTORED IN

The collapsed talks are expected to damage the smaller Sun more than IBM, the world's largest technology services provider, which has fared relatively well despite the global economic slump thanks to its outsourcing business and its shift from hardware to higher-margin software sales.

Kaufman Brothers analyst Shaw Wu said it was a mistake for Sun to reject the bid, citing the leap in Sun shares since reports of the deal talks.

"The acquisition is already factored into the market's thinking. To reject it over 50 cents a share, or whatever it may be, doesn't seem like a very prudent move," Wu said.