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Uphill task for Lenovo
By Jayanthi Iyengar

Days after Lenovo's US$1.75 billion acquisition of IBM's personal-computer (PC) business hit the headlines, the euphoria surrounding the deal is beginning to evaporate as the larger implications of the deal begin to sink in.

It is clear that even if it was not the deal of the decade, it is the stuff that case studies are made of. It is one of China's largest acquisitions at this juncture. It will make Lenovo, already China's largest and Asia's leading computer maker, the world's third-largest producer of PCs after Dell and Hewlett Packard (HP), with 8% of the global market share. The deal has made it possible for Lenovo to acquire a brand ranked the world's third-most-valuable by BusinessWeek and Interbrand. It follows a string of deals over the past two years that have given Chinese companies control of South Korea's No 4 auto maker Ssangyong Motor, television brand RCA and the Asian subsidiary of US phone giant Global Crossing.

For IBM too, this is a deal of significance as it gives Big Blue entry into the burgeoning consumer markets of China even while allowing it to take its laggard operations off its books. The company's PC division was incurring about 2.7% net losses. Lenovo, on its part, commanded 27% of China's PC market share in 2003 and Lenovo PCs ranked No 1 in the Asia-Pacific region (excluding Japan) with a share of 12.6% in 2003. Upon acquisition, Lenovo's world market share will rise to 8% in terms of shipment. As former Lenovo Chairman Liu Chuanzhi said while announcing the deal, "The purchase has changed the landscape of the global PC-manufacturing business."

The deal is a trail-blazer of sorts, for it establishes the Chinese name quickly in the international arena. It is likely to set off a spree of other such deals as other Chinese companies that want to go global in the shortest period of time try to emulate Lenovo's example - one reason why this may not be the Chinese deal of the decade. It is also likely to be the kind of textbook deal from which Chinese acquirers will learn and improve their cross-border acquisition skills.

At another level, this deal is not merely about a Chinese company acquiring a US brand name. It is more than that. It's a major gain for China over the United States on the geopolitical chessboard. It also marks the arrival of the Chinese at the high end of the technology market - more than a mere OEM (original equipment manufacturer) capable of just fulfilling client specifications - as acquirers and owners of technology. That makes this foray not only an example of Lenovo's ambition, but also of the vision of the Chinese government, which has been encouraging its enterprises to go forth and multiply. One needs to remember that it is about a Chinese firm acquiring interests in an American company that struggled and gave up, even though the former is not necessarily in the best of financial health.

Goldman Sachs analyst Laura Conigliaro notes in a research paper, "Judging from past PC-related acquisitions, the acquiring company struggled and typically ended up giving up market share. In past mergers, such as Gateway Inc and eMachines Inc, and HP-Compaq, the combined companies' market share turned out to be less than (that of) the individual merged companies." That raises questions why the stock markets reacted the way they did to the acquisition. Stocks of the Chinese computer maker rose by 6% on the morning of December 9 - after trading had been suspended for three days. But the prices fell by more than 10% by the close of the day to HK$2.58 (US$0.33). Similarly, IBM's stocks on the New York Stock Exchange closed at US$96.65, an increase of 0.57%, on December 8 after the deal was announced. The answer to this behavior lies in the doubts that are now being raised by international bankers and experts, who feel the road ahead may be tough. As Alan Hsieh, president of US IT-market research firm International Data Corp (Chinese mainland, Hong Kong and Taiwan) told Xinhuanet, "Lenovo will have huge challenges on the road ahead."

Jack Z Chen, chairman, Asia-Pacific, of Barrington Associates and a well-known takeover expert, told Asia Times Online, "From a banker's standpoint, it's great because it serves as a case study on a Chinese company buying a piece of the most respected company in the world. Encouraged by such a high-profile transaction, I believe we'll start to see more and more such transactions - that is, Chinese companies acquiring Western companies, which own strong brands, customer base or distribution channels. On the other hand, I am not sure how much good this will do to the combined company."

The deal
After nearly 13 months of negotiation, Lenovo paid $1.25 billion to acquire IBM's entire global desktop and laptop computer research and development, and manufacturing business. IBM, however, would hold on to its services component. In late October, Lenovo completed the sale of its services group to AsiaInfo. About half of the acquisition price has been paid in cash, the rest in stock. As a result of the deal, IBM would now own 18.9% of the Hong Kong-listed Lenovo. The deal price is being pegged at $1.75 billion because Lenovo would also assume $500 million in debt.

The deal is expected to be completed within the next six months. The current Lenovo chief executive officer would become the chairman, while the current general manager of IBM's Personal Systems group would become the CEO, making an American the CEO of the largest information-technology (IT) company in China. The company's headquarters would move from Beijing to Manhattan, though the operations headquarters would move from Raleigh, North Carolina, to Beijing. Lenovo would pick up IBM research-and-development (R&D) centers in Japan and the Research Triangle in North Carolina along with most of a manufacturing joint venture it already has with IBM in Shenzhen, southern China. Lenovo also retains IBM's sales staff.

But nobody is certain which way the systems integrators and value-added resellers will go. Some experts feel that Lenovo's new PC business would benefit from IBM's worldwide distribution and sales network covering 160 countries. Others see a trend similar to the one set by Japanese companies in the 1980s when they went on an acquisition binge. Many, however, say it is too early to reach conclusions and more such acquisitions would have to be seen before such conclusions can be drawn. The Chinese have been crowing about the size of the deal as well as the globalization of China, but competitors HP and Dell are complacent. As Zeng Jiabao, vice president of HPPC China, commented: "HP's PC business accounted for 15% of the global market share in the third quarter this year. This is larger then the world's third, fourth, and fifth PC makers' shares combined. So the Lenovo-IBM deal won't have much impact on our business."

The importance of the deal can be gauged from the reactions it has drawn from different commentators. The People's Daily viewed it in terms of size. "The transaction volume worth $1.25 billion is a new record high for purchasing overseas IT enterprises by Chinese enterprises," it said. The Los Angles Times quoted Donald Straszheim, chairman of the Los Angeles-based Straszheim Global Advisors, which has offices in Beijing and Shenzhen, as saying, "It's a clear indication that one of the things China is buying is expertise. China knows that it don't know how to run a company like this."

The New York Times dubbed it as "a bridge between cultures," while the Taipei Times concentrated on the competition. "Asustek has an advantage in the clone market, where it gained a foothold in motherboard business, to sell its brand-name laptops," said Frank Chi, an analyst with Grand Cathay Securities. The reference to the Taiwanese Asustek stems from the assessment that Lenovo would face stiff competition not only from Dell, Founder and TongFang, but also from the Taiwanese company. Chi's assessment was that Lenovo may lose out in the clone market but that it stands a better chance of successfully competing in a commodity market, which is something that IBM simply did not want to and could not do.

The concerns
Both IBM and Lenovo have made several statements after the acquisition, but they have also expressed concerns. Talking to the media on December 16, announcing IBM and China Great Wall Computer Shenzhen Co Ltd's agreement to establish a new joint venture to produce computer servers for Asia, IBM China chairman Henry Chow said, "In unloading its personal computer business to Lenovo Group, IBM managed to keep the division's most profitable pieces - services and support. In the coming 20 years, we will see IBM and China's IT industry playing major roles in the international market. We hope Lenovo can save our costs by improving efficiency."

Independently, Lenovo has not concealed its worries over the merger. "IBM is too much concerned with big-scale clients and fails to cover small- or medium-sized customers, which are the core target consumer groups in running a PC business," said new chairman Yang Yuanqing. Lenovo has made it clear that it plans to integrate IBM PC business' supply chain as an effort to cut costs. "One year later, Lenovo will unite the two companies' marketing and distribution sectors as its second integration step and after that, Lenovo will march into the international market with a totally integrated image," Yang said.

Explained Jack Z Chen of Barrington Associates, "Lenovo is not the lowest cost producer in the PC industry, nor is it the most efficient. Most PC manufacturers have already been making PCs or components in Asia. As such, lower production cost could not be the consideration of this transaction. IBM's PC unit was a weak player compared to Dell or HP, so there was no superior technology to talk about. This transaction seems more like a big gamble by Lenovo, which was losing market share in China and could not find a way to turn around the company."

Chen cites HP's acquisition of Compaq to elaborate his point. "We know how hard it is to consolidate two companies' operations after such a transaction. With Lenovo buying IBM's PC unit, we have to deal with additional issues. These include among others different cultures (not simply corporate culture) and operating environments." Though Lenovo was ranked high on the rung of PC makers prior to the acquisition, its markets were largely limited to China, with a few PCs being sold in Europe. Following the acquisition, the new entity would have to satisfy the needs of a highly complex international consumer segment.

Said S S Rao, a longtime ThinkPad user and fan, "The hardware itself may not be a problem since Lenovo is acquiring IBM technology. However, I am not so sure about technical support." Columnist Michael Kanellos, CNet's editor at large, questions in the same vein, "How comfortable are business customers going to be with a joint venture owned mostly by a company based 10 time zones away? More likely, they'd rather call Round Rock, Texas, home of Dell. In addition, IBM will likely be uneasy about having its brand name coming out of a group it does not fully control."

This raises the tricky human resource issues. Lenovo is a Chinese company, where a mandatory break for exercise at noon is part of the corporate culture. Expat Americans working with IBM have tended to describe the acquisition among themselves as a "Niagara Falls of tears". The cultural differences apart, this staff would have to draw Chinese salaries in the new company as Lenovo imposes "local hire" conditions on them in place of the dollar salaries they were drawing till now. This staff also cannot apply for IBM jobs since they are banned from doing so under the terms of the sell-off agreement.

Jayanthi Iyengar is a senior business journalist from India who writes on a range of subjects for several publications in Asia, Britain and the United States. She may be contacted at

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Dec 24, 2004
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Lenovo's $1.25bn splurge on IBM (Dec 9, '04)


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