IBM appears close to PC deal

Chinese PC maker Lenovo Group said it is in the advanced stages of discussions to make a major tech deal--one that is widely believed to be with IBM.

The two companies are said to be negotiating a deal to form a complex joint venture that would make Lenovo the third-largest PC maker in the world behind Dell and Hewlett-Packard, but would still give IBM a hand in the PC business. The expected deal would also mark the latest round of consolidation in an increasingly mature and thus slower-growing world PC market.

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Lenovo has acknowledged only "that it is in confidential discussions with a major international company in the information technology industry in relation to a possible acquisition," the company said in a statement released Monday by the Stock Exchange of Hong Kong. If the discussions are successful and definitive agreements are reached, it said, "they may constitute a very substantial acquisition."

The sale is expected to be announced on Tuesday evening, U.S. time--that is, Wednesday morning in China, the New York Times reported Monday. The paper also said that the timing could change or that the two companies could still fail to reach an agreement. Lenovo's statement did not name its potential partner.

IBM has been moving away from so-called commodity products toward selling services, software and high-end computers, so previously reported, a deal with Lenovo would relieve it from managing its challenging and often money-losing PC group, while still giving it access to desktops and notebooks to provide to its customers. IBM could also be eyeing making inroads into the Chinese market as part of the deal. Although it might be giving up a controlling stake in its PC business by working with a local company, Big Blue could gain an edge in selling servers and services in China, a fast-growing market targeted by a number of U.S. tech giants.

A sale could also bring a substantial cash infusion. Big Blue's PC business could fetch as much as $2 billion, the New York Times said Friday when it reported that IBM has been negotiating with Lenovo, formerly known as Legend, and at least one other buyer.

IBM has declined to comment on any potential deal. Lenovo representatives did not return phone calls seeking comment.

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Some financial and market analysts say good things could come from such a deal.

"Based on our analysis of the potential impact and our discussions with industry contacts, we think that the reports are accurate and a deal is likely to be announced soon, which we view as a net positive" for IBM, Steven Fortuna, an analyst with Prudential Equity Group, wrote in a report on Tuesday.

The acquirer of IBM's PC business, Fortuna said, would gain use of the IBM brand, including the ThinkPad name, the intellectual property behind the company's PCs, along with greater scale and purchasing power. Meanwhile, Big Blue would free itself from losses associated with manufacturing PCs. Although IBM's Personal Systems group breaks even or is slightly profitable in a given quarter, Prudential's analysis shows that the profit comes from the cash registers and peripherals IBM sells and not its PCs, which by themselves would lose money.

"We believe a joint-venture structure in PCs makes sense between the companies, as the buyer would collaborate with IBM design teams for a period of a few years and the buyer would assume control of manufacturing," Fortuna wrote.

But many questions remain about the details of any new arrangement. Among them are how the IBM PC group's new owner would handle customer support and marketing, including how it will use the IBM and Think brand names, as well as its manufacturing strategy.

Right now, IBM manufactures ThinkPad notebook models in a joint venture with Great Wall Technology in a factory in Shenzhen,

China, near Lenovo's Hong Kong base. The new owner would likely gain the majority stake in that venture.

But IBM's Think Centre desktop line is produced under contract by Sanmina-SCI in North Carolina, near Raleigh, where IBM's PC business has traditionally been headquartered.

In January 2002, IBM sold Sanmina-SCI its desktop manufacturing operations in the United States and Scotland, which included some 980 employees, for an undisclosed sum. At the same time, IBM signed a three-year contract for Sanmina-SCI to manufacture the desktops. Later, IBM extended the agreement, hiring Sanmina-SCI to build some IBM xSeries server models as well.

Maintaining good relations with IBM's customers will be another concern for the PC group's new owner.

Although analyst firms such as Gartner are advising customers to hold tight until the details of any arrangement are fully disclosed, at least some IBM customers are likely to be nervous about the implications of a potential deal.

"They should not change their buying behavior based on rumor or speculation," said Leslie Fiering, an analyst at Gartner. "Until there's factual information available and the terms and conditions of the deal are known, it's premature to take any action."

It's not yet clear whether IBM would retain some part of technical support or continue to offer service contracts to PC customers, a move that would likely put some customers' fears to rest.

Despite the concerns, analysts have largely said it could be a wise move for IBM to exit the business of building PCs. The timing could be favorable: Although 2005 is expected to be a relatively good year for the PC industry, those good returns will give way to several years of slower sales of PC hardware, analysts have predicted.

By the end of 2005, many businesses and consumers will have replaced their oldest computers, completing the latest PC replacement cycle, Gartner predicted in a report last week. Given that owners typically replace desktops every four years and notebooks every three years, there is likely to be a drop in demand between 2006 and 2008. That period will see average annual unit shipments slow to 5.7 percent and revenue growth subside to 2 percent, Gartner predicted.

So-called emerging markets such as China are expected to see the best growth during that time, a boon for a potential IBM-Lenovo joint venture. But that would be offset by slack demand elsewhere, the Gartner report added, leading to further consolidation if PC makers don't prepare now by lowering their costs.