PC Business Sale A Big Win For IBM But A Big Challenge For Lenovo

On its face, the merger creates the third-largest PC business in the world, with approximately $12 billion in 2003 revenue and an 8 percent market share.

The risk for Lenovo is that it might not add up so easily.

"Judging from past PC-related acquisitions, the acquiring company struggled and typically ended up giving up market share," Goldman Sachs analyst Laura Conigliaro wrote in a research note.

In past mergers, such as Gateway and eMachines, and Hewlett-Packard and Compaq Computer, the combined companies' market share turned out to be less than the individual merged companies, Conigliaro wrote.

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Since some business customers like to buy their entire information technology system and support from a single vendor, this may hurt the combined company, said Alan Promisel, an analyst at research firm IDC.

Another hurdle is that in the years since Lenovo was founded in 1984, it has made its name selling cheap PCs, said Forrester Research analyst Simon Yates. More high-end PCs are selling in China and Dell, but the bulk of the Chinese market is still low-cost PCs.

"They may have bought things they can't sell," he said.

While Lenovo, which has 9,000 employees, is getting a 10,000-person team from IBM and a new chief executive, IBMer Stephen M. Ward Jr., what they're mostly buying is "a number of intangibles," Citigroup analyst Richard Gardner wrote in a research note.

Those include the IBM logo and the company's existing customer relationships, which is one reason Gardner joins other analysts in predicting the company will lose market share to Dell and, to a lesser extent, Hewlett-Packard.

The biggest challenge, said Promisel, "In the PC business, as IBM found out, it's difficult to squeeze out a profit."

Lenovo's obvious hope is that the acquisition will help it gain traction in China's booming economy and win customers in the United States.

For IBM, the reasons to leave the PC market were glaring.

The company had outsourced most of its manufacturing years ago, selling the last PC plants it owned alone in 2003. Since their introduction, its PCs used a Microsoft operating system and Intel chips. The only thing that made them unique was their design, and that wasn't enough to let IBM set above-market prices.

CEO Sam Palmisano said in an e-mail to employees that IBM was getting out of the PC business because it had become too much like consumer electronics, which relies heavily on individual consumers and depends on economies of scale.

Taking PCs off the books will be "a huge benefit to their profitability," Promisel said of IBM.

Returns for IBM's PC business are at the low end of the industry, Morgan Stanley analyst Rebecca Runkle wrote in a research note. According to Goldman Sachs, IBM's PC business is projected to have a pretax profit margin of .5 percent in the third quarter of the company's 2005 fiscal year. Most grocery chains, which set the standard for low margins, do better than that.

IBM may also be getting out at a good time for the overall PC industry. Sales growth in 2004 has been 13 percent, coming off a low point in 2001, according to Goldman Sachs.

"IBM is thus able to exit its most commoditized business before growth rates potentially drop again," Conigliaro wrote.

The new business will be an East-West hybrid.

Of the 10,000 workers in IBM's PC division, 40 percent are already in China and less than 25 percent are in the United States, the company said.

The new company will be headquartered in New York, with major operations in Beijing and Raleigh, N.C. Lenovo senior management will be "primarily U.S.-sourced" IBM said.

But that still leaves one last challenge: How U.S. government regulators will oversee a business where IBM has 18.9 percent ownership and the Chinese government, in the guise of Lenovo's original parent, the Chinese Academy of Sciences, is also major shareholder.

"I don't know how U.S. regulators are going to deal with that," IDC's Promisel said.

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