IBM's Chinese Adventure

By Steve Hamm In a deal that could rock the computer world, IBM (IBM) has agreed to sell most of its $12 billion-a-year Personal Systems Group to China's Lenovo for $1.75 billion. This is no traditional transaction. Lenovo will relocate its world headquarters to New York, and it will be run by a pair of veteran IBM executives, and Big Blue will take a minority ownership stake in Lenovo. It's akin to a joint venture, though legally it's a sale.

The deal, announced after the U.S. markets closed on Dec. 7, brings to an end 13 months of on-again, off-again talks. According to a source close to the negotiations, things almost broke down in September when IBM's Personal Systems Group, which is predominantly PCs, rang up outstanding results -- with revenues rising 17%, to $3.3 billion, on strong sales of ThinkPad mobile computers. After mulling it over, however, Palmisano decided to go ahead with the deal, the source says (see BW Online, 12/6/04, "Sam Palmisano's Many Messages").

The transaction makes sense for both sides. With it, IBM gets to keep selling PCs while no longer owning a PC division that has been a drag on its earnings. Lenovo, which has essentially been bottled up in China, buys itself a global PC company. "Lenovo gets what they want -- a worldwide presence. And IBM gets what it wants. They still have a product offering for their large accounts, but they don't want to be manufacturing commodity machines," says Phillipe de Marcillac, senior vice-president for international business at tech market researcher IDC.

WORKABLE MODEL. IBM has had a wild ride in the PC business. Big Blue gave the nascent industry credibility in corporations when it introduced the first IBM PC in 1981. IBM dominated the industry in the 1980s before losing the leadership first to Compaq Computer (HPQ) and then to Dell (DELL). After suffering huge losses, IBM finally came up with a workable business model in the past couple of years. It sold off manufacturing plants and outsourced most of its production to Sanmina-SCI (SANM) and Solectron (SLR).

Lenovo has it own ups and downs. It's the dominant PC player in China, with a 27% market share, but efforts to expand into servers and services haven't been successful. It has been slowly losing market share -- partly to Dell, which is strong in corporations, but also to IBM, which is No. 1 in mobile computer sales in China. Combined, Lenovo and IBM held about one-third of the country's overall PC unit sales in the third quarter.

A key advantage for IBM is that the deal takes the PC business off its books. In the first nine months of this year, the PC group reported just a $70 million pretax profit on $9.4 billion in sales. Analysts say IBM can improve its overall operating margins by getting rid of the PC business, but it will still be able to potentially profit as a reseller of PCs. Right now 35% of IBM's PC sales go through Big Blue's sales force and its online store, and the rest go through its thousands of resellers.

STRANGE MOMENT. But the deal is no panacea for IBM or Lenovo. For starters, the combined operations still won't be able to match the efficiencies at Dell -- which is a build-to-order business, while Lenovo will still predominantly makes PCs based on forecasts and sell through distributors.

Also, culture clash is a tremendous risk for an organization that will be part Chinese and part American. Lenovo will be run day-to-day by Stephen M. Ward Jr., as CEO, and Fran O'Sullivan, as chief operating officer. Ward is now senior vice-president and general manager of IBM's Personal Systems Group, which includes point-of-sale devices and printers as well as PCs. O'Sullivan is now general manager of the personal systems division -- the PC part. The Beijing-based chairman will be Yang Yuanqing, who is now CEO and vice-chairman. Lenovo's current chairman will retire.

How will the company integrate its operations and who will truly be in control? "The biggest challenge will be how it is managed," says IDC's de Marcillac.

Can Lenovo and IBM pull it off? It will be interesting to watch. This is a strange moment. An icon of Western capitalism is marrying a company that's partly owned by the Chinese government. Weird. But also a sign of the times in this evolving global marketplace. Hamm is a senior writer for BusinessWeek in New York

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