IBM Shrinks Its Lenovo Stake

Lenovo calls Big Blue's share sale routine, but shaken investors sent the Chinese computer maker's stock into a free fall in Hong Kong

Is IBM ready to cash out its chips in Lenovo, the world's third-biggest personal-computer maker?

That's a question many Lenovo investors must now be asking themselves following the news that Big Blue is dumping a sizable chunk of its Lenovo equity stake. The development sent Lenovo shares traded in Hong Kong into a free fall early on Feb. 6, down 7% to HK$3.20 (40 cents), before the computer company requested a suspension of trading.

IBM (IBM) sold its money-losing PC division to Lenovo back in 2005, allowing the Chinese to use the IBM name and Think brand on Lenovo's computers. In return, top IBM people became executives at Lenovo, and IBM got a 13.4% stake in the company. The deal was perhaps the most celebrated cross-border acquisition by a Chinese company at the time and was trumpeted as a sign of the mainland's growing economic clout in global markets.

Sudden shift

But that stake is now shrinking. Reports of the big IBM sale of Lenovo shares—equivalent to 3.5% of the entire company—caught investors by surprise. Lenovo's trading volume, which has averaged about 36 million shares in recent months, shot up to about 314 million shares on Feb. 6, according to data compiled by Bloomberg News.

Lenovo officials were quick to point out that the IBM stock sale was a routine transaction, and didn't suggest tensions or any future severing of the companies' 2-year-old partnership. "We have always known that IBM is not in the business of investing in PC companies, and this comes as no surprise," said Lenovo spokesperson Angela Lee in an e-mailed statement.

She added, "What's important to remember is that this has little or no impact on our highly successful relationship with IBM. IBM has been—and continues to be—a major partner and customer of Lenovo."

Another setback

This is just the latest blow to Lenovo's plans to become the first Chinese tech company to become a global player. The company, long the dominant player in the fast-growing Chinese market, leapfrogged to prominence in the rest of the world after the IBM deal. That purchase catapulted Lenovo to the No. 3 spot globally, behind only Dell (DELL) and Hewlett Packard (HPQ). It also prompted many observers to predict the deal would make Lenovo—with its combination of high-end Western experience and a low-cost Chinese foundation—a fearsome force in the global IT marketplace.

But the company has struggled. Last month, market research firm International Data Corp. revealed that Lenovo's No. 3 position was at risk, with Taiwanese computer maker Acer rapidly closing the gap. Gartner Inc. (IT) differed, maintaining that Lenovo remains comfortably ahead. Yet the research firm reports that the Chinese company's sales increased just 6.9% last quarter, compared to 12.6% growth for the entire industry. Meanwhile, HP grew at 21% and Acer at a torrid 30.9%.

Diversification efforts have also stalled. Lenovo made progress with a move into cell phones in China, but sales fell 6% in the latest quarter. A year ago, Lenovo launched a new line of desktop and notebook computers targeting small- and midsize-business owners in the U.S, but on Jan. 25, Scott Smith, who ran the Americas business for Lenovo, resigned to pursue other interests.

Mitigating profits

On Feb. 2, Lenovo announced that its sales in the Americas had fallen 4%. "The much-expected synergy did not materialize," wrote Manish Nigam, research analyst at Credit Suisse (CS) in Singapore, in a report last Friday downgrading Lenovo's stock rating to underperform.

Still, investors last week took some solace in Lenovo's boosting profits 23% for the last three months of 2006, thanks to aggressive cost cutting. The news that IBM is backing away from Lenovo, however, put a damper on whatever good feeling there was from the surprisingly strong profit growth. The share sale "is just another way that IBM is lessening its direct relationship with Lenovo," said Martin Gilliland, research director for Gartner in Singapore.

That's bad news for Lenovo, which has been counting on its IBM relationship and access to Big Blue's sales-and-distribution network to boost revenue in North America and Western Europe. Lenovo's "access to the IBM customer base lessens as IBM pulls back from their relationship over time," says Gilliland.

'Know-How Is There'

There is still time for Lenovo management—led by CEO William J. Amelio, the former Dell executive who joined the Chinese company in late 2005, along with other Dell veterans—to make things right. The know-how is there, said Bryan Ma, an analyst with International Data Corp. in Singapore. "They are getting hit with a few punches along the way," concedes Ma. "But we are looking at a company that should do well. These are the kind of people who, when they were at Dell, were able to run that like an operational machine."

However, even Lenovo's home turf is no longer safe. One reason for Nigam's downgrade was concern about the Chinese market, which accounts for 80% of the company's entire profit. Operating margins in China were just 5.1% for the last quarter of 2006, compared with 6.5% the previous year.

The reason, writes Nigam, is increasing competition, which is forcing Lenovo to cut prices in order to keep market share. And the situation may get trickier. "Market dynamics could deteriorate further, with Dell expected to get more aggressive when it launches its AMD platform in China," writes Nigam. For Lenovo, "it was first margins that are seeing the brunt; next could be market share."

IBM is moving away from Lenovo just when the Chinese company could use a friend.

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