Why the Lenovo/IBM server deal is a watershed

A salesperson mans a Lenovo outlet in Beijing. Lenovo's shares saw a 3.5% jump on the Hong Kong stock exchange after confirmation that the putative deal with IBM would go ahead.

Background

The investment world has been buzzing this past week with the news that PC manufacturing giant Lenovo may acquire IBM’s lower-margin server division. Thursday saw a confirmation of these guesses, with Lenovo announcing to the Hang Seng (Hong Kong’s stock exchange), that they would purchase the entire division for $2.3bn, one of the largest tech acquisitions of the past few years and coming just a few weeks after Google’s acquisition of home automation firm Nest for $3.2bn.

In spite of the furor and headlines, the news came as less of a surprise to those accustomed with Lenovo’s change in the strategy over the past few years, which has included diversifying its hardware line-up in the face of declining PC sales and efforts to break out into enterprise software and server providing. Lenovo’s attempts to establish itself as an IT company have been fairly transparent for some time.

Indeed, this isn’t the first time Lenovo have made an offer for Big Blue’s low-end, x86 server division. Two years ago Lenovo made overtures to IBM but investors were put off by what they saw as Lenovo’s potential inability to compete against the likes of Dell, Microsoft and HP dominance in the server space and Lenovo first got a foothold in the PC manufacturing space by acquiring IBM’s then flagging PC manufacturing arm, Thinkpad, in 2005. Since then they’ve proved their skeptics (and there were many) wrong and established themselves as the largest per-unit manufacturer of PCs and laptops in the world, overtaking HP in the third quarter of 2013.

Why IBM?

Lenovo’s efforts at diversifying themselves aren’t some executive’s whimsical idea either. They’re part of a concrete and long-term strategy. At the moment Lenovo manufactures basic server hardware (what are called single and dual-socket racks) and they’ve been moderately successful in using this to break into the server market amongst small-to-medium sized enterprises in a limited way. However, to really gain traction in this space they need to leverage their basic hardware offerings alongside dependable software, an area where East Asian companies have traditionally been weak (think of Samsung or Sony’s OEM software). To this end they’ve signed deals with software companies like Citrix so that they can offer their clients desktop virtualization options, among other things.

IBM’s server business was 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. As a result, another potential IBM acquisition on the server front seems to the next logical step to build up a globally competitive IT servers portfolio. It allows Lenovo to further establish themselves as a go-to name for SMEs whilst diversifying their revenue streams away from the aforementioned flagging PC sales. Furthermore, much like their purchase of IBM’s thinkpad division, this is also just as much about acquiring credibility to mount a challenge at established players in the US market.

Lenovo’s future

Don’t expect this to represent a tactical retreat from emerging device markets where Lenovo have been somewhat less successful in developed markets (although Q4 2013 figures show ascendant market share in developing ones). Yang Yuanqing, Lenovo’s CEO, signaled that he wants the company to challenge Apple and Samsung’s dominance in these markets in the long term, and build a name for itself as a headline-grabbing trend-setter.

Ultimately Lenovo, much like that other Chinese tech-giant Huawei, want to be a jack-of-all-trades technology conglomerate, with Samsung and Japanese Keiretsus as their template more than any Western company. The difference with Lenovo is in what they can leverage nationally: a domestic labor pool of 1.3 billion increasingly skilled workers to recruit from, easier access to raw materials than any South Korean chaebol and a domestic market growing in purchasing power by the day. Lenovo therefore has at least the potential to become bigger than Samsung by an order of magnitude.

Whether they can achieve this without replicating a similarly vertically integrated approach, moving away from ODMs like Hon Hai/Foxconn in the process, remains to be seen however.

Categories: Industry Research

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s