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Lenovo to buy IBM's low-end server unit for $2.3 billion

Boxes containing Lenovo desktop computers are seen in an office in Kiev March 12, 2012. REUTERS/Gleb Garanich
Boxes containing Lenovo desktop computers are seen in an office in Kiev March 12, 2012. REUTERS/Gleb Garanich

By Paul Carsten and Soham Chatterjee

(Reuters) - Chinese PC maker Lenovo Group Ltd has agreed to buy International Business Machine Corp's low-end server business for $2.3 billion in what would be China's biggest technology deal.

The long-expected acquisition comes nearly a decade after Lenovo bought IBM's money-losing 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 - would allow IBM to focus on its decade-long shift to more profitable software and services.

The deal would increase Lenovo's share in the server market to 14 percent from 2 percent, said Peter Hortensius, a senior vice-president at Lenovo.

The deal needs clearance from the Committee on Foreign Investment in the United States (CFIUS), which protects 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 scrutiny before approval, and this time will be easier, analysts said.

"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, a partner at law firm Davis Polk & Wardwell in Washington, D.C. who has handled CFIUS issues for 20 years.

Reynolds saw relatively little national security risk in the deal, noting that Lenovo was well-known in the United States.

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

This deal is likely also to win U.S. antitrust approval, perhaps within weeks, said Jonathan Lewis, an antitrust partner with Baker & Hostetler LLP. "Given that Lenovo is likely to take advantage of its lower-cost manufacturing base in China, this deal is likely to be viewed as pro-competitive."

IBM shares edged 0.2 percent lower to $182.27 at mid-afternoon Thursday. Trading in Lenovo shares was halted before the close in Hong Kong ahead of the announcement.

SEVEN QUARTERS OF LOSSES

The deal with Lenovo marks another step in IBM's switch away from hardware to software and services. IBM said this month 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 cloud services to businesses and consumers.

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

It would not be easy for Lenovo turn around the server unit, however. IBM's low-margin server business has posted seven quarters of losses as clients move to the cloud.

"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 with Hewlett-Packard Co and Dell but lags both in market share.

IBM dominates the higher-end server market with a 57 percent share, according to research firm Canalys. IBM will retain its higher-margin server systems and continue to develop software and applications for the x86 platform.

Following closure of the deal, Lenovo will offer jobs to 7,500 IBM employees 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," said Lenovo's Hortensius.

Analysts said Lenovo would 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 clout of China's technology firms as they 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 posted 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 is the biggest player, while Lenovo does not appear in the top five.

Lenovo said it was advised by Credit Suisse and Goldman Sachs Group.

(Additional reporting by Diane Bartz in Washington; Editing by Denny Thomas, Stephen Coates, Ryan Woo, Ted Kerr and Richard Chang)

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