Lenovo's IBM server deal faces near-term challenges

Hardware companies typically lose market share after mergers, but bounce back later

PUBLISHED : Saturday, 25 January, 2014, 5:29am
UPDATED : Saturday, 25 January, 2014, 7:03am

After basking in the glow of its US$2.3 billion deal to buy the commodity server business of International Business Machines, it's time for Lenovo to face up to some of the uncertainties the major acquisition brings.

That was also evident from the resumption of trading in the company's shares yesterday after being halted on Thursday, when the IBM deal was announced.

Lenovo's share price climbed early to hit HK$11.28 - its highest mid-day peak since reaching HK$11.45 on April 14, 2000 - before finishing at HK$10.44, up 1.16 per cent.

Its performance showed that investors are not only well aware that Lenovo must bear the rigours of obtaining regulatory approval but also of the fact that the company will encounter inevitable teething problems from integrating IBM's low-end server business into its global operations, according to analysts.

"Historically, hardware mergers and acquisitions have resulted in initial share loss for the combined companies," Toni Sacconaghi, a senior analyst at Bernstein Research in the US, said in a report yesterday.

He cited as examples Hewlett-Packard's US$25 billion merger with Compaq Computer in 2002, as well as Lenovo's US$1.75 billion acquisition of IBM's personal computer business in 2005.

Both HP and Lenovo initially lost market share during their post-merger phases. They eventually regained lost ground to become formidable competitors in the personal computer market.

Lenovo was the world's third-largest personal computer supplier, with operations in about 160 countries, after the IBM deal in 2005. It was soon bumped into fourth place, restructured its operations and survived a global recession, while replacing two chief executives during that post-merger period.

Lenovo's reformed business strategy and other key acquisitions this decade paid off last year when the company ended HP's six-year reign as the world's top supplier of personal computers.

Alberto Moel, a Hong Kong-based senior analyst at Berstein, said Lenovo's acquisition of IBM's x86 server division "will not likely achieve its full synergy".

IBM sold its business unit that makes and sells commodity x86-standard servers, the low-cost, general-purpose corporate computers used to run business applications and which serve as the basic hardware inside large storage systems, as well as in data centres. Lenovo would become the world's third-biggest x86 server supplier, with a 14 per cent market share, upon the deal's completion.

Moel, however, pointed out that "IBM retained some of the higher-margin services revenue as part of an outsourcing contract [with Lenovo]". In addition, the sales process for servers, as well as research and development resources, will require higher operating expenses "even if Lenovo can manage to run the business more efficiently than IBM".

Sacconaghi said the IBM server deal "will take at least six months to close" as Lenovo will be investigated by the Committee on Foreign Relations in the United States, a government panel that reviews foreign acquisitions for national security risks.

The typical length of the committee's review is 30 days, but it can also order a probe that lasts 45 days. The US president is the final arbiter, with the power to allow or reject the deal after the investigation.

"We believe the x86 server deal could trigger a 45-day investigation, especially given that servers play a more critical role in company and government IT infrastructure," Sacconaghi said, adding that there is tension between Beijing and Washington following the US spying revelations made by whistle-blower Edward Snowden.