View from Silicon Valley- Lenovo/IBM
Part 2: After the spin...
(c) Copyright View from Silicon Valley, 2004. All rights reserved.
The Lenovo /IBM deal has been described a lot of different
ways. Lenovo has one take, IBM gives another. Chinese newspapers described
the deal one way, the US papers from a different persepective.
IBM CEO Sam Palmisano,
in a verymatter-of-fact tone, claimed, "What we wanted was not
a divestiture, but this strategic relationship with Lenovo and China." You might
think IBM was doing Lenovo a favor.
Xinhua in China countered,
"When Lenovo...agreed earlier this month to purchase IBM’s personal computer division." Sounds like Lenovo
did IBM a favor, but only after some persuasion.
Picking a source outside
the US and China, Japan's Asahi.com, "personal computers are already commodities... IBM's decision to sell off its PC arm
should not be seen as a surprising move." Sounds like divestiture to me.
We could go on and on, but the reality is IBM sold,
and Lenovo now owns, IBM's PC business, and IBM's "ThinkPad" trademark -- worldwide. Forever.
A number of the features of the deal are likewise getting "spin" from one side or
the other. Let's walk through a few of the highlights.
The terms are $650M cash plus $600M in Lenovo Group stock
plus $500M in assumed debt. Headlines proclaim the $1.75B price tag but it's only $650M cash. IBM owns
18.9% of the combined company.
Less than three years ago, Hewlett-Packard paid $19B (initial
offer: $22B) for Compaq in an economy-of-scale acquisition. Of course, H-P acquired more than just Compaq PCs.
Compaq's Y2K annual sales were $42.4B total with $20.7B in PCs. Compaq's PC operation was ~$9.3B
of the $19B deal.
This suggests H-P paid $0.45 for every dollar of Compaq's PC
sales three years ago. Fast forward, Lenovo's ~81% ownership of IBM's ~$9B in PC sales costs only $1.15B.
This works out to less than $0.17 on the dollar for IBM's PC sales. ($0.24 if you count the implied value
of the stock, much of which is still owned by the Chinese government.)
Who wouldn't rather have IBM's brand instead of Compaq's?
Especially if IBM is selling for a 62% discount to Compaq's 2001 price? Isn't the PC business supposed
to be "better" at the end of 2004 than it was in 2001?
Remember, the justification
H-P used to acquire Compaq was the several billion in cost reductions the combined HPQ could achieve. HPQ would
force price cuts on top of cutting redundant operations and personnel. Perhaps not from day one but, clearly, Lenovo
must have a similar agenda. As discussed in "Part 1" you need scale, (i.e., reduced unit costs), to survive the on-going compression in the PC business.
Perhaps to distract us from the above price comparisons,
heavy "spin" was imparted to other facets of the deal:
"IBM PCs will still be sold with the IBM brand
name."
Well, duh! The IBM brand has to be preserved
to combat Dell and HPQ's well-publicized efforts to steal IBM's customer base. Who is going to buy an little-known Chinese brand when they can call that
same machine an IBM instead?
"Lenovo also gets exclusive access to the IBM logo for five years and permanently
acquires the "ThinkPad" brand."
In other words, Lenovo has five years to build
their own brand on top of, and to replace, IBM. Five years from now, you can buy a Lenovo-brand "ThinkPad."
Why wouldn't Lenovo want that deal?
"Lenovo will pay IBM fees for warranties and technical
support."
Notice no minimum term is publicly attached to
this part of the deal. How long before tech support is quietly outsourced? Or combined with current Lenovo tech
support in China?
"IBM will provide financing to PC customers."
Wasn't vendor financing derided as one of the
most foolish aspects of the dot-com bubble? With IBM doing the financing, Lenovo is getting paid up-front.
IBM may turn a profit from financing but is also taking 100% of any payment risk. Lenovo's accounts receivables
will now be 100% from IBM, not from individual customers. Such AR quality may be attractive for
Lenovo's future financing opportunities.
"IBM's salespeople will be able to pitch Lenovo's
PCs as well as other brands to their corporate clients."
Let's see, IBM keeps the sales force on their
own payroll and this sales force will now sell Lenovo/IBM PC's along with the rest of the IBM product
line? Lenovo gets the sales exposure without the fixed costs! What's not to like if you're Lenovo?
"IBM will supply the CEO for the new entity."
Lenovo admits they need and want to
learn how to run an international business such as IBM's PC operation. What better way than to hire the existing IBM
staff and move a bunch of your in-house execs to New York (and Raleigh) for a few years to learn first-hand?
IBM is supplying the company, the product line and now the executive training Lenovo will need to take over the whole
operation.
"I.B.M. is placing 10,000 of its employees with Lenovo."
In other words, IBM
downsized 10,000 people. (IBM is smooth! I sure didn't know 40% of IBM's PC workforce was already off-shored
to China.) Since US employees cost eight to ten times what Chinese employees cost, when Lenovo moves to cut
headcount, where do you suppose they will start? Of the 25% still in the USA, 1,900 are in Raleigh (76%).
I wouldn't want to be selling a house in Raleigh starting in about 12 -18 months...
In classic spin-management, each of these
points is reported as a positive for IBM. As though Lenovo was getting the short end of the stick.
Lenovo, should have demanded each of
the above conditions before doing the deal. The time needed to build a US staff and operation from scratch would
be fatal to the market share and reputation of the brand. Now, with the above conditions, Lenovo has the luxury of time.
They can use this time to pick and choose what, and who, to keep while they bring in their own people.
Not widely reported is a P&L comparison. IBM's $9B in "high-end" notebook sales
achieved zero net profits. (You figure break-even is just saving face by the accountants.) Lenovo's
$3B in "low-margin" desktop sales made a profit!
When the smaller company, presumably with
inferior operating leverage, is more profitable, something is happening. Perhaps the reduced cost
of operating in China really is a significant differentiator?
As an aside, this "spin" is reminiscent of
the Daimler/ Chrysler "merger" a few years back, which was advertised as a "merger of equals." A short few months
later, with most of the top Chrysler execs forced into "retirement," it was clear to all who was in charge.
Conclusion: IBM is orders of magnitude smoother
and more sophisticated than most tech deal participants, but the driving force behind the Lenovo's
purchaseis the same:
-If you get bigger, you reduce
unit costs.
-When you lower costs, you gain market share.
-If you're not gaining market share, you're not
winning.
