Today, in an announcement that came as a shock to no one in the industry, Applied Micro Devices revealed it would spin off its chip manufacturing business into a separate entity and focus its efforts on microprocessor design. The newly hatched manufacturing organization will be called “The Foundry Company.” Tuesday’s announcement was the culmination of AMD’s so-called “asset smart” initiative, which was designed to relieve the chipmaker of the expense of maintaining its own fabs.

The deal was made possible by an infusion of money from the Advanced Technology Investment Company (ATIC), which will own a majority share in the newly created foundry company. ATIC will ante up $2.1 billion to purchase its initial stake and has promised an additional $3.6 billion to $6.0 billion over the next five years. Meanwhile, the Mubadala Development Company has come up with another $314 million to increase its current share in AMD proper to 19.3 percent. Both ATIC and Mubadala are owned by the government Abu Dhabi, the capital of the United Arab Emirates. And thanks to $4.00/gallon gasoline, the region is swimming in even more money than usual.

The deal might not be a slam dunk, however. Since it involves access to semiconductor technology, the agreement will have to be approved by the U.S. government, which in its infinite wisdom, regulates such things. Of course, IBM just sold Blue Gene technology to a Saudi Arabian research center, so presumably the Feds won’t have any qualms about handing over a stake in x86 manufacturing to one of the more progressive regimes in the Middle East.

But this is an election year, and if the public ever looks up from its shrinking stock portfolios long enough to notice that AMD is being bailed out by an Arab government, you can probably kiss this deal goodbye. It was just two years ago that the concerns about national security forced Congress and the Bush administration to nix the sale of U.S.-based port management businesses to a Dubai company.

Apparently Intel is already questioning the deal, based on their cross-licensing agreement with AMD. In an X-bit Labs piece, the author points out that AMD may not have a lot of wiggle room on how it can share its x86 intellectual property:

The wide cross-licensing agreement between AMD and Intel, which is also believed to cover x86 instruction set, does not allow AMD to transfer any of Intel’s technologies to any third-party. As a result, if AMD itself is acquired, the new company will not have rights to produce x86 central processing units (CPUs) or utilize any technologies from Intel. While AMD can outsource part of its production, contract manufacturers can only legally produce 20% of AMD’s total output, according to some claims.

Most industry insiders think that AMD has no choice but to divest itself from its manufacturing business (and even this reorganization only partially accomplishes that). The increasing cost of fab retooling with each process technology shrink is forcing most chipmakers, save Intel, into manufacturing partnerships to defray the crushing expense. In a Computerworld article, John Lau, a senior semiconductor analyst and managing director at Jefferies & Co., noted that the spin-off was a necessary move for AMD’s business, saying: “This fab spin-out changes the equation on how to remain competitive. Now it’s a design race.”

AMD’s business was probably never going to be large enough to sustain its own manufacturing arm. But the company’s missteps over the last couple of years, including its problems in integrating the ATI acquisition and the delay of the Barcelona processor, forced the issue even sooner. The reorganization will certainly slow some of the red ink AMD has been bleeding for the past year and a half.

If the spin-off deal falls through, the U.S. government will probably be forced to pick up the pieces. There’s too much industry resistance to allowing Intel free reign in the x86 market. One of the original roles of AMD was to act as a second source for x86 chip production for the IBM PC back in the 1980s. Twenty years later, the x86 has spread into every computing segment and is now the dominant architecture in PCs, workstations and servers.  If AMD isn’t there to counterbalance its larger rival, x86 prices will go up and innovation will go down. Intel would be ecstatic for awhile, but in the long term, it would likely shrink the market.