Lenovo Buys IBM's Low-End Server Business for $2.3 Billion

Lenovo buys IBM's server business in China's biggest IT acquisition
Cancan Chu/Getty Images

By Paul Carsten
and Soham Chatterjee

BEIJING -- Chinese PC maker Lenovo Group Ltd agreed to buy IBM's low-end server business for $2.3 billion in what is set to be China's biggest technology deal.

The long-awaited acquisition comes nearly a decade after Lenovo bought IBM's loss-making ThinkPad business for $1.75 billion, eventually becoming the world leader in personal computers in 2012.

The sale of the low-end server operation -- which still needs U.S. government approval -- will allow IBM (IBM) to focus on its decade-long shift to more profitable software and services.

IBM said earlier this month that it would spend more than $1.2 billion to build up to 15 data centers on five continents to expand its cloud services and reach new clients and markets.

The company also said it would invest more than $1 billion to establish a new business unit for Watson -- the supercomputer system that beat humans on the TV quiz show "Jeopardy" -- to offer the cloud services to businesses and consumers.

Lenovo's acquisition would lift its market share in the server market to 14 percent from 2 percent, said Peter Hortensius, senior vice-president at Lenovo and president of its Think Business Group.

The deal needs clearance from the Committee on Foreign Investment in the United States, %VIRTUAL-article-sponsoredlinks%which is charged with protecting U.S. national security. Chinese companies faced the most scrutiny over their U.S. acquisitions in 2012, according to a CFIUS report issued in December.

Lenovo's purchase of IBM's notebook division faced similar scrutiny.

"It's fair to say that this deal is more likely to get through CFIUS without major problems than the 2005 transaction," said John Reynolds, who heads the regulatory practice at law firm Davis Polk & Wardwell in Washington, D.C., and has 20 years of experience dealing with CFIUS.

Reynolds said there seemed to be relatively little national security risk in the deal, adding that Lenovo was now a fairly well-known corporate citizen compared with 2005.

Maybank Kim Eng analyst Warren Lau also noted that the System X server, among the systems bought by Lenovo, is based on commoditized technology and components that are sourced from the United States.

7 Quarters of Losses

With Lenovo's PC business under siege from powerful smartphones and super-fast tablets, the company is diversifying its revenue and remodeling itself as a force in mobile devices and data storage servers.

Lenovo would have its work cut out for it to turn around the server unit, however. IBM's low-margin server business has posted seven quarters of losses as more clients switch to cloud storage from traditional infrastructure.

"To generate costs synergy, Lenovo will need to move most of the manufacturing from IBM's existing facility in Virginia to Asia while keeping some R&D in the U.S.," Lau said.

The server business being sold by IBM, which produced low-cost x86 servers, competes Hewlett-Packard Co and Dell but lags both in market share.

IBM dominates the higher-end server market with a 57 percent market-share, according to research firm Canalys.

IBM will retain its higher-margin server systems and will continue to develop software and applications for the x86 platform.

Following closure of the deal, Lenovo will offer jobs to 7,500 IBM employees around the world and assume customer service and maintenance operations.

"We will do a variety of things -- improve products, drive improved costs, and couple it with the scale we have and our PC business to improve go-to-market," Hortensius said.

Analysts say Lenovo will likely find it easier than IBM to sell the x86 servers to Chinese companies as Beijing tries to localize its IT purchases in the wake of revelations about widespread U.S. electronic snooping.

Biggest Tech Deal

Lenovo said it expected demand for computing power and recovery of global enterprise spending to further drive growth in the x86 server market.

Lenovo has agreed to pay $2.07 billion in cash and the rest with stock of the Hong Kong-listed PC maker.

The deal surpasses Baidu Inc's $1.85 billion acquisition of 91 Wireless from NetDragon Websoft Inc last year, according to Thomson Reuters data, and underscores the growing clout of China's technology firms as they look to expand overseas.

The unit posted a loss of $26.4 million after tax for the 12 months ended December 31, compared with a profit of $187 million in the 12 months ended March 2013. The x86 unit has annual revenue of $4.6 billion.

Talks between IBM and Lenovo fell apart last year due to differences over pricing, with media reports at the time suggesting IBM wanted as much as $6 billion for the unit.

Analysts said the sale may have been accelerated by IBM's problems in China following revelations of U.S. electronic spying and ongoing weakness in hardware sales.

The world's biggest technology services company reported a 23 percent drop in fourth-quarter revenue from China.

Lenovo's purchase of IBM's PC business in 2005 became the springboard for its leap to the top of global PC maker rankings, and the market is betting Lenovo will enjoy similar success with its latest acquisition, which is partly reflected in a 9.44 percent rise in its shares this year. The Hang Seng stock index is down 2.5 percent in the same period.

IBM's server business is the world's second-largest, with a 22.9 percent share of the $12.3 billion market in the third quarter of 2013, according to technology research firm Gartner.

Hewlett-Packard (HPQ) is the biggest player, while Lenovo doesn't appear in the top five.

"The acquisition presents a unique opportunity for the company to gain immediate scale and credibility in this market," Lenovo said in a statement Thursday.

Lenovo said it was advised by Credit Suisse (CS) and Goldman Sachs Group (GS).

Originally published