News

IBM's PC deal seen as strategic withdrawal

• By John K. Waters
• December 13, 2004

IBM's decision this past week to sell a majority stake in its personal computer business to Lenovo Group, a vendor based in China, for $1.75 billion in cash, stock, and debt assumption, is probably as much about getting into new markets as it is about getting out of the PC business.

"The Lenovo deal creates a great opportunity for IBM in the Chinese and Asian marketplace," says Yankee Group analyst Andy Efstathiou. "IBM is much more concerned with services, and this gives them the opportunity to sell services through Lenovo in China, while Lenovo takes over their PC business domestically and elsewhere."

Douglas Hayward, senior analyst at UK-based Ovum, agrees. "[With this deal] IBM gets its name on the desktops of the world's fastest growing and potentially largest IT market, China," he says. "Seems like a win-win situation to us."

This isn't the first time Big Blue has sold off a low-margin business. The company sold its disk drive business to Hitachi in 2002, and it sold its printer business 15 years earlier to Lexmark.

"IBM has a strategy of exiting direct participation where margins are very low," says Efstathiou. "If they're not in the top one or two with a differentiating advantage in the marketplace-they were third in the PC business, with a very thin profit margin, and not much prospect for changing that-so they put that business on its exit list."

Most industry watchers have been expecting some form of vendor consolidation in the PC industry. Researchers at Gartner published a report in November predicting that three of the top 10 PC manufacturers would exit the market by 2007. A statement in that report by Leslie Fiering, research VP for Gartner's Client Platforms group, seemed almost prescient: "Exiting the market may be the only logical choice for global vendors bleeding profits and struggling for [market] share," she said.

IBM has reportedly just broken even on desktop computers over the past few years, but it still managed to generate about $10 billion in annual PC and laptop sales.

What was for IBM a marginally profitable business is likely to act like rocket fuel for Beijing-based Lenovo, which is now poised to become the world's third-largest computer maker. The IBM deal catapults Lenovo's share of the world PC market from 3% to 9%. Dell still leads with 18%, and HP comes in a close second with 16%, but Lenovo now beats everyone else. Among Chinese brands, Lenovo is already the market leader at home, with about a third of the country's PC market.

Stephen M. Ward Jr., who currently serves as senior vice president and general manager of IBM's Personal Systems Group, is signing on as CEO of Lenovo; Yang Yuanqing, currently vice chairman, president, and CEO of Lenovo, will serve as chairman.

Most of the top executives in IBM's PC unit are expected join Lenovo, including the division's general manager Fran O'Sullivan, who will become chief operating officer.

As part of the agreement, Lenovo, formerly known as Legend, will retain the right to use IBM's powerful, globally recognized ThinkPad brand names for five years.

Lenovo will also become the preferred supplier of PCs to IBM, while IBM will become the preferred services and financing supplier to Lenovo -- gaining, observes Forrester analyst Simon Yates, access to the rapidly growing Chinese IT market.

Even without the new channel into Chinese markets, the IBM-Lenovo deal is likely to prove to be a smart move for IBM says Ovum's Hayward. "IBM wants to move up the value chain, and sees its future in higher end consultancy and IT services as well as the higher value hardware and software products, which appeal to its core corporate customers," he says. "The price paid -- at just 15% of the division's revenues -- might look a bit bargain basement. But given that its PC operations contributed 13% of revenues but less than 1% of its profits, IBM's profit margins will be considerably improved. Most of IBM's IT services customers buy PCs from a range of suppliers anyway."

The bottom line for enterprise customers, says Forrester's Yates, is proceed with caution when considering IBM as a best-and-final candidate in PC refresh negotiations. In a Forrester "Trends" report, published just last week, he writes: "Although IBM retains a significant stake in the new company, the degree to which IBM will control or influence long-term product and quality remains to be seen."

Forrester also expects both HP and Dell to offer "enticing trade-up deals" to IBM's existing customers.

The deal is expected to close in the second quarter of 2005; both companies are expected to operate independently until then.