Sam Palmisano's Many Messages

Selling IBM's PC unit would be a telling move about the future of Big Blue, about the tech industry, and even about Corporate America

By Spencer E. Ante

IBM Chief Executive Samuel J. Palmisano has never been your typical suit. During his 31-year career at Big Blue, he has taken bold actions and broken with IBM (IBM ) tradition when it made strategic sense. When he ran IBM's server group, the former center of the Johns Hopkins football team drove the company to embrace the then-radical Linux operating system.

Nine months into his job as CEO, Palmisano turned heads by scooping up the consulting arm of PricewaterhouseCoopers for a reasonable $3.9 billion. And just before celebrating his first-year anniversary in the top spot, Palmisano disbanded IBM's hallowed 93-year-old executive-management committee and set up a more decentralized operating structure to speed up collaboration and decision-making. All of these moves have proved to be prescient and profitable -- Palmisano was well on his way to remaking an American icon (see BW Online, 12/3/04, "Is Big Blue Back?").


  Now it appears as if Palmisano is making perhaps his boldest move yet: Getting IBM out of the personal computer business. By marketing a PC in 1981 with clever commercials that featured a Charlie Chaplin-like figure, IBM helped transform a geeky niche market into a mainstream business touching households and businesses across America. Some analysts have been cajoling IBM for years to exit the ultracompetitive business, but it looks like Palmisano is the one who has the guts to break so starkly from the past.

If sold, IBM's $12 billion PC unit is expected to fetch $1 billion to $2 billion. IBM has struggled to make money selling PCs, and the commoditized machines don't help IBM hold onto customers nearly as much as they used to. In the first nine months of this year, the PC group reported a $70 million pretax profit, on $9.4 billion in sales.

A source close to the deal confirms that IBM is discussing the business' sale with Lenovo, China's largest PC maker, and with at least one other bidder. The transaction may ultimately involve some creative dealmaking in which the two outfits become partners and Lenovo maintains the IBM brand on PCs while IBM continues to own the sales and service relationship. Other potential acquirers may include a private-equity firm or another Asian computer maker. "IBM wants to continue to be the face to the customer," says Gartner analyst Tom Bittman.


  If the deal happens, it would bolster Palmisano's strategy of moving up the tech food chain. The concept is to exit commodity hardware technologies and bulk up in higher-margin software and services businesses. What's more, the potential move raises all sorts of fascinating questions about IBM's future and holds implications for Corporate America and the technology industry at large.

If IBM dumps its PC division, it wouldn't radically change the way the outfit does business. Big Blue already exited the consumer PC business years ago, and in January, 2002, it sold off its desktop PC manufacturing operation to contractor Sanmina-SCI. The more significant impact would be the symbolism of such a transaction.

First, Palmisano is sending a strong statement to IBM employees. The message is that services, software, and high-margin hardware, such as computer servers, are more than ever the way of the future.

Sure, Palmisano has thrown mature hardware businesses overboard before. In one major transaction early in his tenure, IBM sold off its hard-disk-drive business to Hitachi (HIT ). But because PCs have played such a major role in IBM's history and corporate identity, this would be the strongest sign yet that the new Big Blue will look very different than even the Lou Gerstner-era outfit.


  The PC divestment suggests that IBM may be cooking up some more big deals to help it compete in the growing and lucrative services and software markets. In software IBM may be interested in acquiring players specializing in infrastructure software, which improves security or the ability to manage sprawling computer networks. In services, IBM seems to be most interested in expanding its footprint in the market for so-called business process outsourcing. As IBM takes over and runs business operations for its clients, it will need to beef up its expertise in a whole range of industries.

"The opportunity for IBM to continue to build on a market-leading position in software and services is full of potential," says Ben Howe, CEO of Boston-based boutique investment bank America's Growth Capital. "I expect they'll be out over the course of the next six months with more acquisitions than any of the other top technologies in the world."

Second, Palmisano is sending a strong message to Wall Street that by shedding the PC albatross, IBM is positioning itself to become more of a growth company. In a research note published on Dec. 3, Merrill Lynch analyst Steve Milunovich pointed out that "exiting PC manufacturing should have a positive impact on IBM's return on capital" and improve its gross margins.


  Consider this back-of-the envelope calculation: If IBM stripped out the results of its PC division, its overall growth rate for 2003 would have been 10.8%, instead of 9.8%. What's more, without the money-losing PC business in 2003, IBM's pretax margin would have been 14.2%, instead of 12.2%. That's a percentage point in sales and two points in margin right off the bat. And it doesn't include the benefits that will probably come from increased focus.

Finally, Palmisano may be firing a shot at Corporate America and the technology industry. The sale of such a large business by an iconic industry leader to a Chinese concern may presage a bevy of future transactions with China and other Asian-based outfits. Ever since the disastrous purchase of the overvalued Pebble Beach golf course, Asian companies have been reluctant to strike a major U.S. deal.

But some investment bankers think Asia is on the verge of becoming an acquirer again as it seeks out more lucrative places to deploy its capital. "The Asians will be coming after U.S. assets in the next two to three years," predicts Howe.


  Similarly, the technology industry may take a look at this deal and conclude that not just any kind of scale will do. IBM may have to give up the PC unit's $12 billion revenue stream, but Palmisano's strategy of amassing profitable, high-margin scale seems preferable. In that sense, a PC divestment would be a salvo aimed at Hewlett Packard (HPQ ), putting pressure on the No. 2 computer maker to prove that it can turn a significant and consistent profit in PCs or other low-margin hardware.

Of course, the deal to sell its PC division may not happen. But even if it falls apart, Palmisano shows that he continues to think boldly.

Ante is Computer editor for BusinessWeek in New York

Edited by Beth Belton

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