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Weekly Column

The China Syndrome: If You Want to Understand IBM Selling Its PC Division, Just Look East

Status: [CLOSED]
By Robert X. Cringely

This week, as anyone knows who reads the business section of their local newspaper, IBM sold its personal computer division to Lenovo, a company presently based in mainland China. How far we have come! When IBM announced what was then its Entry Systems Division and introduced to the world the underpowered, overpriced, but fantastically successful IBM Personal Computer, China wasn't even a major trading partner with the U.S. Who would have guessed that times would change so much and so quickly? And who also would have guessed that all the analysis we've been reading about this transaction could be so shallow and misleading? There is far more to this deal than people are being told.

The simple story -- and the only one that made it in most papers -- is that IBM hasn't made much of a profit on PC products for years, so selling out is a simple way of improving corporate results and shifting capital to where it can be used more profitably. Well, yes and no. PCs HAVE become a commodity, and IBM hasn't made money on them since the late 1980s, but this story goes far beyond raising gross margins and cutting pension liabilities.

Take a look at the price, for one thing. There is a mix of cash and stock and assumption of debt amounting -- all-told -- to about $1.8 billion, which is a lot of money, but remember, this is for a chunk of IBM that last year produced $9.2 billion in sales. Setting the price at 20 percent of sales sure seems low, even if there is little profit. The question that ought to be asked and generally hasn't been is, "What would Carly Fiorina of Hewlett-Packard have paid for the same property?" Carly, whom you'll remember not that long ago paid $25 billion for Compaq Computer, would certainly have paid two to three times what Lenovo has for the chance to leapfrog Dell and become the world's largest producer of personal computers, along with the largest computer company of any kind.

Okay, so IBM didn't want to make HP an even bigger competitor, then why not sell to a big Japanese player like NEC, which after all paid more than $1.8 billion for Packard Bell, of all things. The dollar is down, the yen is up, and the cost of corporate borrowing in Japan is almost free, so why didn't IBM sell to a Japanese company? Or a European one? Or even another American company? Gateway paid more cash for e-Machines than Lenovo is paying for IBM; Wouldn't Ted Waitt have ponied-up big bucks for the use of the IBM brand? Of course he would have.

What is absolutely key to this deal is that the buyer is Lenovo, the largest Chinese PC manufacturer. Yes, the division was unprofitable and IBM would have eventually had to do something about it, but Sam Palmisano wanted a Chinese buyer and was willing to accept far less cash than he might have received elsewhere just to get the buyer he wanted.

IBM got rid of a headache and in doing so, gained unique access to what will shortly be the world's largest IT market. This deal is all about China, not the U.S.

Doing business in China always requires having a partner. You don't just set up an IBM China and start selling stuff. You find a local partner company and move into the market together. Now IBM's partner will be Lenovo, the biggest, baddest PC maker in China, which is a good partner to have. IBM not only has its Chinese partner, it has a substantial equity position in that partner as a result of this transaction. That's unique as far as I know. Chinese-U.S. corporate partnerships aren't always the easiest marriages, but in this one, IBM actually has a vote. It also got Lenovo to move its global headquarters to the U.S. and accept an American CEO and 10,000 U.S. employees, which will have to change the way Lenovo runs its global business.

In any other U.S.-China corporate partnership, a top-level meeting requires a 20-hour plane ride, but the top guys at IBM and Lenovo can meet for lunch at Denny's. All this is nothing but good for IBM. Look for this partnership to expand inside China to cover much more than just personal computers as IBM tries to become the number one or two player in every segment of Chinese IT.

Can you see now why Sam's so excited?

But wait, there's more!

While IBM will still have design input on future PC products and those products will continue to carry the IBM brand for five years, the company will shortly have severed any major financial dependence on the future of those product lines. In short, this is the end of the line for IBM's marriage with Intel. Sure, they'll continue to sell boxes containing Intel (and perhaps AMD) processors, but the historic link is severed, with the result that IBM will be able to compete with impunity using its PowerPC and Power5 processors.

What Palmisano has done is clear the decks so he can compete unfettered in a completely different segment of the market -- servers -- where IBM DOES make money and where they will now proceed to crush the competition.

IBM's PowerPC investments are beginning to show impressive results. If you look at their November 9th press release on the p5-575 "super computer," IBM shows it can now comfortably combine and cluster scores of processors into a relatively small blade center chassis.

Then consider the chip fabrication innovations -- silicon on sapphire, copper, and now germanium -- and IBM has a strong technology advantage here too. Throw in the cell processor that will shortly be used by Nintendo, Sony and in IBM's own workstations, and you have an interesting product road map completely devoid of Intel heritage.

As the silicon manufacturer, IBM will be able to make some remarkably powerful computers and own the high-end computational computing market for many years to come. In this space, IBM will have a cost advantage. And thanks to this Lenovo deal, they won't have to worry at all about any effect on the low-end business. They'll only have to price their systems to compete with HP and Sun, and on a dollars-per-MIPS basis, IBM should be able to be more profitable as a result because, while the PC world has slim-margin commodity pricing, the high-end is different.

And even in the PC business, IBM is suddenly much freer to sell PowerPC chips to HP and Dell, though I really doubt that will happen -- not unless Microsoft suddenly opts for a PowerPC version of Windows. But stranger things have happened before, eh?

Winners in this deal are IBM, Lenovo, AMD, and Dell. Lenovo instantly doubles its market share. AMD eats away just a little bit more at Intel's power base. Dell, as the true PC market leader, will rely on its lower overhead to further hurt HP.

Losers in the deal are HP, Intel, and Sun. Especially Sun. Those guys are in trouble.

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