While reading reports about Lenovo's (OTCPK:LNVGF) new blockbuster deal to buy IBM's (NYSE:IBM) low-end server business for $2.3 billion, I felt a strange and unusual lack of enthusiasm from Lenovo's usually upbeat Chairman Yang Yuanqing. Yang never met a reporter he didn't like, and he loves to talk about Lenovo's big hopes and dreams at every opportunity he can get. Yet in the reports I read, this talkative chief executive was decidedly low-key and not extremely bullish on this new mega-deal, his company's largest and the biggest ever tech acquisition by a Chinese firm. Perhaps that's because he senses trouble ahead as his company tries to integrate and promote a business whose slowing growth was the main reason IBM desperately wanted to sell the unit.
Anyone sensing a repeat of Lenovo's landmark purchase of IBM's PC assets nearly a decade ago may have reason some reason for concern. That $1.25 billion deal was also the biggest-ever purchase for Lenovo at that time. Like the server business, the IBM PC unit that Lenovo bought was also struggling to earn money in a maturing and highly competitive sector. The purchase ended up being quite difficult for Lenovo, which ultimately underwent a major corporate restructuring before it finally returned to health.
There are a number of reasons to believe that history won't repeat itself with this latest purchase. But before we explore that, let's take a look at the deal itself and why Yang's remarks didn't seem to come from a man who was very excited about his new mega-purchase. Under the deal, Lenovo will acquire IBM's low-end x86 server business for $2.3 billion, far less than the $5-$6 billion IBM was initially seeking. (company announcement; English article; Chinese article)
The deal will give Lenovo about 12 percent of the world's server market, third behind industry leaders Hewlett-Packard (NYSE:HPQ) and Dell. The fact that IBM was ultimately willing to lower its asking price so much probably reflects its strong desire to get rid of the unit while it was still profitable. The unit's lack of profitability and weaker long-term prospects were clearly at the front of Yang Yuanqing's thoughts at a media briefing to discuss the deal.
Yang was careful to point out that the unit was just barely profitable, even though he added he was confident about its long-term prospects. His most positive comments were that Lenovo would enjoy a sharper growth curve following the deal, an obvious conclusion since his company's sales will immediately jump around 15 percent with the addition of a unit that now generates about $5 billion annually. The deal also marks a divergence from Yang's recent emphasis on building up Lenovo's newer smartphone and tablet PC units, which both have far strong growth potential than the more mature PC and server businesses.
All that said, I do still believe there's reason for optimism that this deal will fare better than the earlier purchase of IBM's PC business. For starters, Lenovo now is a far different company than the one that had little or no experience outside its home market at the time of its first IBM purchase in 2005. That deal gave Lenovo a huge operation in the state of North Carolina, which it can now use to integrate this newest purchase. What's more, the server business is also highly complementary to Lenovo's core PCs, and should give the company a more complete product line to better serve its corporate customers. On the whole this particular deal doesn't seem too exciting, but I'd still call it modestly positive for Lenovo over the next 5 years.
Bottom line: Lenovo's purchase of IBM's low-end server business is a distraction from its new focus on smartphones and tablet PCs, but will be modestly positive for the company over the next 5 years.