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A SPECIAL ANNEX NEWSFLASH
Updated 12/08/04, 10:20am MST (adds Done Deal!, Chart)
An Analysis of a Possible Sale of IBM PC Business
Good Riddance, Finally?
IBM Reportedly in Negotiations to Sell Its Beleaguered Unit to China's Biggest PC Maker
PHOENIX, Dec 3 - If what the New York Times reported this morning is true - that IBM is in negotiations to sell its beleaguered PC unit to Lenovo, the largest Chinese PC maker, a story about which IBM had no official comment - the move deserves loud cheers and a long applause. Perhaps not as long as it took for IBM to finally "hear us" (over 12 years!), but long enough to be heard around the globe.
The fact that IBM seems to have finally heard us and is acting accordingly, is certainly a breath of fresh air coming out of Armonk. "Getting rid of its losers is the kind of a move that we also said was necessary if IBM is to grow again..." (see Annex Bulletin 2004-10, Apr 7, 2004 - "). It was only the last in a series of articles dating back to August 1992 (see Appendix A below, "Robbing Peter to Pay Paul") in which we expressed similar sentiments. And again in March 1996, when we urged Gerstner to break up IBM and sell its PC unit close to its peak (see Appendix B and the chart).
The New York Times seems to have also noticed it. "For nearly a decade, though, some industry analysts have urged I.B.M. to get out of that business as it made only a modest profit or lost money, the Times said. "For this year, analysts have expected a pretax profit of less than $100 million."
Last year, the IBM PC unit lost $118 million pretax on revenues of $11.4 billion. This year, we figure that will grow to over $13 billion (see the chart).
Paying $1 billion to $2 billion for a $10 billion-business doesn't seem like much. Except when you consider that the PCs have not done much for Big Blue's bottom line during the 23 years of their existence. Then it could seem too much. That's because IBM PC losses piled up, especially in the early 1990s, when we first urged that IBM get out of this business. So paying something, anything... to take this headache off IBM's shoulders is doing Big Blue a favor.
The stock market seemed to agree. The IBM stock moved up about 1.5% to $97.22 on the news of a possible sale, and on Intel's bullish outlook for PC demand.
As for the Lenovo shares, traded on the Hong Kong exchange, they barely moved on the news. As you can see from the above chart, the Chinese company's stock has generally moved with the ups and downs of the PC market (read Intel, the bellwether PC stock). Lately, it's been both up and down, but generally up, along with the entire global PC market.
Lenovo, partly owned by the Chinese government, had sales of over $3 billion last year. It is ranked eighth globally among the PC makers. It is the overall leader in Asia, except in Japan, where NEC, Fujitsu and other Japanese companies dominate. The fact that IBM PC sales are also brisk in Japan (IBM is ranked fifth there) makes the possible deal even more complementary to Lenovo's Asian market ambitions.
Lenovo was formed in 1984 by a group of Chinese scientists with government financing. The company then known as Legend started out as a distributor of computers and printers, selling IBM, AST and Compaq PCs in China. As the market began to get commoditized in the late 1980s, Lenovo started to build its own PCs. By 1997, it had surpassed IBM to become the largest seller of PCs in China.
The timing of the IBM PC sale is auspicious. After peaking in 1999 at over $15 billion in revenues, the PC unit's business had contracted at about 6% per year. Now that it is a growing concern again (we expected it to increase by 16% this year), and it is even making some money, why not put it on the block?
Goodbye Charlie! (Charlie Chaplin had been IBM PC's first mascot). And good riddance to red ink at Big Blue.
Happy bargain hunting!
PHOENIX, Dec 8 - It's been a long time coming, but it's a "done deal" now. After 13 months of secret negotiations that the New York Times reporters cracked last week, Lenovo and IBM announced today (Beijing time) that the largest Chinese PC maker is buying the IBM PC unit for $1.25 billion plus $500 million in Big Blue liabilities. Lenovo will pay IBM $650 million in cash and up to $600 million in stock, or about 19% of its equity.
IBM will record a one-time gain of $900 million to $1.2 billion when the transaction closes in the second quarter of next year. Bib Blue will retain a 19% share of the new world's No. 3 PC vendor, and Lenovo will retain the right to use the IBM brand name for five years. The new company will be headquartered out of New York.
Steve Ward, currently IBM senior vice president and general manager of IBM's Personal Systems Group, will serve as the CEO of Lenovo following completion of the transaction. Yuanqing Yang, currently vice chairman, president and chief executive of Lenovo, will serve as chairman of Lenovo.
That's the nub of the deal. Sweet. An obscure Chinese company becomes a global IT player practically overnight. IBM gets rid of the dud (by its standards), and records a gain. It's a win-win for both sides.
IBM CEO Sam Palmisano said in a statement to employees that the decision to sell was part of IBM's continuing effort to focus on high-margin businesses.
Palmisano should know that better than most. He once ran the IBM PC business. Or putting it more succinctly... he survived the PC business on his way to the top.
The Lenovo deal is also sweet for this writer from a personal standpoint. It's the vindication of his point made to IBM's former chairman Lou Gerstner in March 1996 - that smaller can be better in business. Here's an excerpt from the Annex Bulletin "Break Up IBM!":
At the time, our recommendation made quite a splash in the global media (see the slide from our 1996 workshops). But it fell on deaf ears in Armonk.
The former IBM chairman responded in August 1996 saying that breaking up IBM was "a dumb idea" (see “Louis XIX of Armonk,” Aug. 1996). Guess Lenovo's Yang and IBM's Palmisano thought otherwise... to the benefit of their respective shareholders.
Better late than never.
 When this writer first heard the name Lenovo, he thought it was a Russian company.
 By the way, many companies would give their eye teeth for IBM duds. And have made a mint out of them. Think Lexmark, for example
Volume IX, No. 92-44
August 28, 1992
Copyright 1992 by Annex Research. All
IBM To Cast Off Its Calves First, Instead Of
THE "NEW" IBM: "ROBBING PETER TO
time this September,
IBM is expected to announce a "new" unit which will handle its
low-cost personal systems. The
reason the word "new" is in quotes, is that the truly new part
of the venture will be its reduced Selling, General and Administrative
(SG&A) expenses. This
will make it appear that the IBM PS
line can stand on its own. But,
appearances can be deceiving. Last
year, the IBM PS LOB caused the corporation to lose a lot of money.
As if that weren't enough, this IBM unit also lost about seven
market share points. This
year, things have gone from bad to worse.
And even with the new lower SG&A expenses, the new PS unit will
barely make ends meet (see the
casting off a new PC unit is precisely what IBM Canada Ltd. also did on
June 4, when it spun off Exper-Comp Services Ltd., a new subsidiary which
will sell cheap IBM personal systems and even clones (like
the Ambra, an offshore clone). The
IBM announcement meeting was unusual in that it was held at a trendy
downtown Toronto restaurant. At
the time, IBM Canada hailed the move as a new philosophy of "high
style and low prices," just like those at the "Maccheroni
the U.S., IBM is expected to dedicate to the new PS LOB a "blue
suit" sales force of only 500 people.
They will handle about 2,300 "named" corporate accounts.
The needs of all other IBM PS customers will be served by indirect
distribution channels. As a
result, the new unit's sales overhead will certainly be much lower than
IBM's corporate SG&A expenses. But,
some other IBM LOB will have to pick the tab.
So, what's the point of this "robbing Peter to pay
Eliminating "Cash Cows:" Hardly A
"IBM wants to eliminate the 'cash cow's' subsidizing of others," one industry source contended in our conversation this week in New York. "That's what (John) Akers said last year" (see CMS BULLETIN 91-32, 6/18/91). "Then IBM has a funny way of doing it!" we replied. "A sure way of implementing such a strategy would have been separating the 'cash cow' from the calves. Spinning off one of its weakest and thirstiest calves, while the rest of the weaklings keep feeding off the stronger LOBs' anyway, will hardly 'eliminate the 'cash cow'-syndrome, will it?" Our listener nodded pensively.
IBM had its shareholders' best interests at heart, we continued, a better
way would have been to spin off the ABS LOB first, then the ES or AdStar
in the week, we also had a chance to discuss these issues with a senior
IBM executive. We asked Mr. X
if he could explain the rationale for splitting off the PS LOB first.
He said that he'd give us the "party line," but did not
want us to think that he himself believed it all.
What follows is an approximation
of that conversation.
1. FAST TECHNOLOGY CHANGES DEMAND SHORTER PRODUCT
Systems is the part of the business which drives the technology the
fastest. As a result of such
torrid pace, this LOB must have the quickest product development, and the
shortest delivery to market cycle. It
is believed within IBM, Mr. X said, that spinning off a subsidiary would
free it from being constrained by the IBM rules.
Which, in turn, would shorten the product-to-market cycle, and
make the PS LOB more nimble.
agreed. But then, the same
argument could be made for almost any part of IBM.
So, why go first with the PS LOB?
2. CONTROLLING DISTRIBUTION CHANNELS
X said that the second reason for spinning off a PS LOB is that its
distribution costs represent such a big part of the total product costs.
As the pace of competition in Point 1. (above) increases the pressure on gross margins, it becomes important
to be able to control the distribution costs.
In IBM terms, this "control" means that the PS LOB would
not carry the full IBM marketing overhead, as the rest of the LOBs are
supposed to. "I am not
persuaded," this writer said. "This
only means that someone else will have to pick up the tab."
3. PLAYING THE DESKTOP TREND
X continued by saying that the third reason is the industry trend toward
desktop computing. "IBM
cannot afford NOT to be a player in this market," he described the
arguments advanced by the proponents of an independent LOB.
"'Other IBM LOBs benefit from this,' they say.
The question is -- is this worth IBM losing a lot of money?"
4. OUTLASTING THE COMPETITION
answering his own (above)
question, Mr. X added the number four reason -- outlasting the
competition. Some people
think, he said, that the current price wars will result in an industry
shakeout. So, if IBM hung in
there long enough, other players may leave the market first.
After that, things would get better again, the pro-PS LOB advocates
reason. "Why throw good
money after bad?" this writer thought, but said nothing.
5. PROFITING FROM SOFTWARE AND SERVICES
fifth reason is that a large share of profit in the PC business comes from
software and services. "That's
another reason for tolerating the hardware losses," Mr. X said.
"So, the PS LOB's business premise is based on the 'privilege'
of giving away the hardware?" we asked partially
tongue-in-cheek. He laughed.
"Exactly!" he replied.
"But, who says you have to have hardware" (to
play in the software/services game), we asked a rhetorical question.
"Why not be just a software and/or value-added service
supplier, and leave the commodity business to the companies with lower
expenses and smaller margin expectations than IBM's?"
The basic flaw with the entire IBM "restructuring," we
continued, was that no one seems to be asking the question "what kind
of a business do I want to be in?"
"Remember: I didn't say I believed all of it either," Mr.
conversation on this subject seemed to be grinding to a halt.
"Is that it?" we asked.
"Those are all the reasons?"
Mr. X seemed to be straining to think of another one.
"Pretty much," he finally said.
we said. "My turn now.
Let me give you a few reasons why splitting off the PS LOB first
may be a BAD idea. Let's
start with the PR. 'Everybody'
knows that this LOB has been a big money loser for IBM.
So, why focus the world's attention on a company's WEAKNESS?!
People who are not well versed in IBM's business may say; 'Gee: all
I ever see or hear in the media is IBM PC, IBM PC....
And if IBM is losing money in the PC business, just think what the
rest of the company must look like!?'
If such a person were also an IBM shareholder, he may even pick up
the phone, call his broker, and say: 'Sell!'"
6. ATTRACTING OTHER INVESTORS
just thought of a number six reason," Mr. X interjected.
"Attracting other investors."
"That should have been the number one reason, in my
books," we replied. "But
just where, do you suppose, IBM would find a big enough sucker? (to buy the money-losing PS LOB).
These are big numbers, you know.
There aren't many people with that kind of money.
And those have it, usually are not suckers."
Mr. X grinned.
said that if one were dressing up the IBM portfolio from the shareholders'
standpoint, one would try to talk about success stories first, such as the
ES, ABS or the AdStar LOBs. "I
feel that the management's primary responsibility must be to the
shareholders," this writer said.
Of course, making customers happy will often mean making
shareholders happy, too. But, not always. Giving
products away, for example, may please customers, but would probably anger
shareholders if it caused losses.
added that if we were managing the "IBM portfolio," we'd spin
off the ABS unit first. "Strategically,
it should go among the first, and mechanically it would be easier to do
than the ES, for example," we explained.
Secondly, such a "good news" story would be good for
IBM's corporate PR, too. "And
since the ABS LOB has a good story to tell, this would probably boost the
market value of the IBM stock," we concluded.
Nevertheless, stand by for the money-losing PS LOB to go first.
And for the "new" IBM's stock to remain in the
however, appears to be September 22.
the ES or AdStar LOBs from the rest of IBM.
CMS BULLETIN 86-44, 11/06/86).
The mainframe LOB (ES), by contrast, rarely exhibits high public
Volume XII, No. 96-19
(c) Copyright 1996 by Annex Research. All rights reserved.
Steps to Riches: How Should IBM Be Split Up?
1: Spin off and
report separate financial results for the IBM Global Services, including
the Integrated Systems Solutions Corp., its outsourcing subsidiary, as
well as maintenance.
Sell the PC Division and the other low-margin hardware operations, such
as OEM, and/or other low-margin hardware products.
3: Consolidate the
remaining high-margin product businesses - S/390, AS/400 and RS/6000
into a single IBM Server company. It
should include the respective OS software (OS/390, OS/400 and AIX).
4: Evaluate the
feasibility and desirability of spinning off the non-OS software into a
separate business, such as the network-related (Lotus+),
or other IBM software (e.g., middleware; VisualAge,
systems management tools/Tivoli,
market the new IBM market value proposition - “smaller is better” to
some Wall Street “stoneagers.”
6: Increase the IBM
dividend as the financial benefits rise (i.e., the shareholders’
Would It Take?
would it take for Gerstner to make our six-step blueprint a reality?
- because he would have to act more boldly than any other IBM chairman
since Tom Watson’s (Jr.) S/360 project (in the early 1960s).
- because Gerstner would have to give up the empire-building, and
concentrate on creating wealth for the shareholders, including himself,
Gerstner Have What It Takes?
Does Gerstner have the courage and the humility to do it?
(An excerpt from Annex Bulletin 96-19, Mar 20, 1996, "Break up IBM!")
Evidently he did not. Which is why eight years later, Sam Palmisano is having to clean up the leftovers of the Gerstner administration.
For additional Annex Research reports, check out...
2004 IT: IBM PC: Good Riddance, Finally? (Dec 2004); Fujitsu: Recovery Continues (Nov 2004); IBM Server Renaissance (Nov 2004); HP Hits Home Run (Nov 2004); HP Hits Home Run (Nov 2004); Capgemini: Revenue, Stock Soars (Nov 2004); EDS: Jordan's Swan Song? (Nov 2004); To Russia with Love and $ (Oct 2004); IBM: Slow Quarter No Longer (Oct 2004); Accenture: Revenues, Profits Up, Stock Down (Oct 2004); Capgemini: A Takeover Target? (Oct 2004); Sellout of America (Oct 2004); Spy Wars (Sep 2004); Outsourcing Boomerang (Sep 2004); EDS to Cut Up to 20,000 More Jobs (Sep 2004); Capgemini Stock Plummets on Unexpected Loss (Sep 2004); HP Savaged by Wall Street (Aug 2004); Moody's Lowers the Boon on EDS (July 2004); HP: Delivering Value Horizontally (June 2004); Accenture: Revving Up a Notch (June 2004); Beware Your CFO! (May 2004); IBM: Changing of the Guard (May 2004); Capgemini: Texas-size Home Run (May 2004); Following the Money (May 2004); EDS: On a Wink and a Prayer (Apr 2004); HPS Wins by a Nose! (Octathlon 2004); Accenture: Burning the Track (Mar 2004); IGS: "Crown Jewel" Restored? (Mar 2004); HP: Still No Cigar (Feb 2004); Cap Gemini: Another, Smaller Loss (Feb 2004); CSC: Good Quarter Gets Boos (Feb 2004); EDS: "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); IT Industry: Whither Goeth It? (Jan 2004); Cronyism Is Alive and Well at EDS" (Jan 2004)
2003 IBM: "IBM vs. HP: Spinning Global Server Market Shares" (Nov 2003); "Finally Heard, Part II," (Nov 2003), “Small Is Now Big at Big Blue” (Oct 16), “On the Nose But No Cigar” (July 16), “A Paler Shade of Blue” (June 2), “Save, Spend and Split” (May 8), “Shrunk by the Marketplace” (Apr 17), “Turnaround Continues...” (Apr 15), "Finally Heard!" (Jan 29), “Start of a Real Turnaround?” (Jan 17).
2002 IBM: “Gerstner: The Untold Story” (Dec 27), "Gerstner Spills the Beans" (Dec 13), "On a Wing and a Prayer" (Oct 21), "IBM-PwC Tie the Knot" (Oct 2), Big Blue Salami (June 19), "Looming IBM Layoffs" (May 14), "IBM 5-Yr Forecast: From Here to Eternity?" (Apr 2002), “Tough Times, Soft Deals,” (Apr 25, 2002), “Gerstner’s Legacy: Good Manager, Poor Entrepreneur” (Jan 2002), IBM Pension Plan Vapors: Where Did $17 Billion Go? (Mar 2002), "Sir Lou OutLayed Lay!" (Apr 1, 2002).
A selection from prior years: Is IBM Cheating on Taxes, Annex Bulletin 99-17 (May 1999), IBM 5-year Forecast 2001: An Unenviable Legacy (June 2001), "Break Up IBM!" (Mar. 1996), Fortune on IBM (June 15, 2000), “Smoke and Mirrors Galore,” July 2000), "Slam Dunk of Bunk" (Jan 2000), Annex Bulletin 98-14 ("Wag the Big Blue Dog"), Armonk's Fudge Factory (Apr. 9, 1999), Where Armonk Meets Wall Street, Greed Breeds Incest (November 1998), Stock Buybacks Questioned: Is IBM Mortgaging Its Future Again?, 97-18 (4/29/97), "Some Insiders Cashed In On IBM Stock's Rise, Buybacks" 97-22, 7/27/97, Djurdjevic’s Forbes column, "Is Big Blue Back?," 6/10/97; “Executive Suite: How Sweet!,” (July 1997), "Gerstner: Best Years Are Behind", Aug. 10, 1999), "IBM's Best Years Are 3-4 Decades Behind Us" (July 1999), "Lou's Lair vs. Bill's Loft" (June 1999), "Corporate Cabbage Patch Dolls," 98-39, 10/31/98; Djurdjevic’s Chronicles magazine October 1998 column, "Wall Street Boom; Main Street Doom", “Louis XIX of Armonk,” (Aug. 1996), "Mountain Shook, Mouse Was Born" (Mar. 25, 1994), “A Nice Guy Who Lost His Compass” (Jan 26, 1993), “Akers: The Last Emperor?” June 1991), Industry Stratification Trend (Mar. 30, 1990), etc.]