The two companies announced a plan to form a complex joint venture that would make Lenovo the third-largest PC maker in the world, behind Dell and Hewlett-Packard, but still give IBM a hand in the PC business. The acqusition is expected to be completed in the second quarter of 2005.
Under the deal, IBM will keep an 18.9 percent stake in Levono. The joint venture is expected to ship around 12 million units based on 2003 numbers and have annual revenue from PC sales of US$12 billion.
Lenovo will be the preferred supplier of PCs to IBM and will be allowed to use the IBM brand for five years under an agreement that includes the "Think" brand.
Lenovo is the eighth largest PC maker worldwide, according to the latest market share numbers compiled by Gartner.
The combined venture will have roughly 10,000 IBM employees in its PC group and 9,200 employees at Lenovo.
Executives for both companies trumpeted the importance of the acquisition.
Chuanzhi Liu, current chairman of Lenovo Group, said, "As Lenovo's founder, I am excited by this breakthrough in Lenovo's journey towards becoming an international company."
"Today's announcement further strengthens IBM's ability to capture the highest-value opportunities in a rapidly changing information technology industry," said Sam Palmisano, IBM chairman and chief executive officer.
If it goes through, the deal would allow IBM to continue its shift from selling so-called commodity products toward selling services, software and high-end computers. Although it helped make PCs a global phenomenon, IBM makes little profit from PCs and often loses money, despite the fact that it's an US$11 billion business for the company.
During the past several years, IBM has edged out of the commodity hardware business by selling its PC factories in North Carolina to Sanmina-SCI and its hard drive unit to Hitachi. IBM is also likely eying making more inroads into the Chinese market by working with Lenovo to gain an edge in selling servers and services in China, a fast-growing market targeted by a number of U.S. tech giants.
Financial analysts say selling the remainder of the PC business to a joint venture with Lenovo could add more than 5 cents per share to IBM's earnings in 2006, or US$85 million in net income.
"We believe a joint-venture structure in PCs makes sense between the companies, as the buyer would collaborate with IBM design teams for a period of a few years and the buyer would assume control of manufacturing," Steven Fortuna, an analyst with Prudential Equity Group, wrote in a report Tuesday.
Meanwhile, it would give Lenovo the opportunity it has always craved to expand beyond China. In 2002, the company began to slightly expand into Spain and regional European markets, but retreated due to market share losses at home.
The big problem, however, is that the deal combines two radically different companies. Lenovo performs very little independent R&D and mostly manufacturers low-end systems. More than half of its sales go to consumers and very few systems get sold outside China, where it has strong ties to the government.
IBM sells to the cream of the corporate crop and often to customers who have invested heavily in IBM services and software. Its flagship ThinkPad notebooks come with novel design features like fingerprint readers for additional data security and hard drives that can survive a 6-foot drop.
Challenges ahead
"This is going to be a bigger challenge than both companies think. You are talking about a company (Lenovo) that has no experience internationally. They are very shrewd but they are only used to dealing in the Chinese market," said Joe D'Elia, research director for client computing at iSuppli. "It is going to take quite a long time to consummate, and the only way I see this running properly is that if a lot of blood is shed at IBM PC."
The deal also won't just require getting IBM and Lenovo getting along together. Sanmina-SCI owns the factories where IBM PCs for North America are produced and its contract to make those PCs is up for renewal next year. Because Lenovo does not have the factory capacity in place, the joint venture will have to negotiate a new relationship with Sanmina.
In China, IBM manufactures ThinkPad notebook models in a joint venture with Lenovo arch-rival Great Wall Technology.
Maintaining good relations with IBM's customers will be another concern for the PC group's new owner.
One IBM customer said that as long as products such as the ThinkPad follow familiar paths, he will stay happy.
"We tend to base our decisions on quality control, features and functionality," said Shawn Nunley, director of technology development for NetScaler, in San Jose, Calif. "So if it's the same product, where it's coming from probably won't make a huge difference. However, if they go the commoditization route...and it's no longer the ThinkPad way, then it might change my view."
Nunley said he appreciates the work that IBM has done to integrate security features into its latest ThinkPads.
For Steve Evans, vice president of information systems for the PGA Tour, sticking with IBM will depend on the details of the transaction and how much of the new company would be concentrated nearby. The PGA buys ThinkPads, servers and other IBM hardware.
"We would need to figure out what the presence this company is going to have in the U.S.," Evans said, adding that "It would also kind of depend on what the product lineup looked like.
Lenovo who?
Lenovo, formerly known as Legend, is the largest PC maker in China and was founded in 1984 as a distributor of IT products. Over the years it started its own PC business, growing into the No. 1 spot in China. It also sells products ranging from cellular phones to supercomputers.
During 2002, it ramped up plans to sell PCs globally. It even opened a Silicon Valley office and started selling laptops in Spain under its QDI brand. But it's been beaten back by competition from multinational PC makers, such as Dell, which have been growing rapidly in China. Dell, for instance, won a US$10 million contract with Beijing's municipal government to supply Optiplex to primary and middle schools in November.
Lenovo said it has responded to "irrational price competition among second-tier PC vendors and increased effort of foreign brands" with price cuts of its own.
Despite the concerns of customers, industry analysts have said it could be a wise move for IBM to get out of building PCs. The timing could be favourable: Although 2005 is expected to be a relatively good year for the PC industry, those good returns will give way to several years of slower sales of PC hardware, analysts have predicted.
By the end of 2005, many businesses and consumers will have replaced their oldest computers, completing the latest PC replacement cycle, Gartner predicted in a report last week. Given that owners typically replace desktops every four years and notebooks every three years, there is likely to be a drop in demand between 2006 and 2008. That period will see average annual unit shipments slow to 5.7 percent and revenue growth subside to 2 percent, Gartner predicted.
So-called emerging markets such as China are expected to see the best growth during that time, a boon for a potential IBM-Lenovo joint venture. But that would be offset by slack demand elsewhere, the Gartner report added, leading to further consolidation if PC makers don't prepare now by lowering their costs.
Still, potential rivals are already throwing cold water on the deal.
"We're not a big fan of the idea of taking companies and smashing them together. When was the last time you saw a successful acquisition or merger in the computer industry?" said Michael Dell, chairman of Dell, during a question-and-answer session at Oracle Open World. "It hasn't happened in a long, long time...I don't see this one (IBM-Lenovo) as being all that different."
