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Case Study on Lenovo and IBM

Case Study on Lenovo and IBM

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Published by Michael Green
Case studiy related to the PC Giant - Lenovo and IBM
Case studiy related to the PC Giant - Lenovo and IBM

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Categories:Types, Research
Published by: Michael Green on Dec 29, 2012
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03/17/2014

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 The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division
By John Ackerly & Måns Larsson1/28
Harvard Business School
The Emergence of a Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division
 
A Final Paper Submitted to Professor Mihir DesaiByJohn AckerlyMåns LarssonCambridge, MADecember 2005
 
 
 The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division
By John Ackerly & Måns Larsson2/28
Introduction
On May 1, 2005, the Lenovo Group acquired IBM’s personal computing division (IBMPC) for $1.25 billion, achieving the goal of its ambitious founder, Liu Chuanzhi, to create a globalPC manufacturing powerhouse. By transforming itself from an upstart company focused on itsdomestic market, Lenovo joined an exclusive club of Chinese companies, such as Huawei andTCL, which compete head-to-head with leading multinational corporations.Without the involvement of western private equity firms – Texas Pacific Group (TPG),Newbridge Capital,
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and General Atlantic Partners (GA) – this transaction may never have beenconsummated. Each firm brought crucial expertise and credibility that helped mitigate thesignificant financial, operational and cultural risks inherent in a large scale, cross-bordertransaction. Many believe that these efforts opened a new chapter in the growth of China’seconomy and its integration with the West. As Bill Grabe, GA’s representative on Lenovo’s board,stated: “Lenovo’s acquisition of IBM mark the start of something bigger. In the future, we will seemore Chinese global giants emerging through cross-border M&A.”
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 This paper examines the underlying motivations and assumptions of each party in thetransaction. While this transaction had many risks, we conclude that the strategic rationale wassound, the ultimate valuation was fair, and that all players are positioned to benefit: IBM shed aresource consuming, non-core asset; Lenovo leapfrogged to global leadership; and, the privateequity players negotiated and structured a deal with significant upside potential with limiteddownside.The paper reaches these conclusions by answering four key questions:
 
What was the strategic rationale for and key risks of the acquisition?
 
 
Why did the private equity buyers get involved in the transaction? What were theunderlying motivations of the interested parties?
 
 
 How was the deal structured to address the assumed risks?
 
 How did Lenovo think about the valuation of IBM PC? What was the “fair” value of IBM PC at the time of the transaction?
 
1
Newbridge Capital is an affiliate of TPG. Hereafter, “TPG” will refer to Newbridge as well as the Texas PacificGroup.
2
William Grabe, interview by authors, December 6, 2005.
 
 The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division
By John Ackerly & Måns Larsson3/28
SECTION 1: What was the strategic rationale for the acquisition and whatwere the key risks?
Strategic rationale
The Lenovo-IBM PC transaction was underpinned by sound industrial logic. Thecomplementary nature of their businesses across geographies, products and areas of functionalstrength opened a number of win-win opportunities for buyer and seller. As outlined below,though the deal offered significant opportunity for revenue synergies, the cross-bordercombination ultimately was viewed as “cost play” by the parties involved.When IBM decided to spin out its PC division in April 2004, its motivations were clear: thedivision recorded a net loss of $258 million in 2003 and $171 million in 2002 and had required atotal parent company equity infusion totaling $987 million as of June 2004.
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In addition, thedivision was an “orphan” within the organization, as it did not fit within IBM’s broader strategy tofocus on higher margin enterprise and services businesses.The initial interest in IBM PC came from financial buyers such as TPG who were attractedto the carve-out of IBM PC as a stand alone entity.
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These players sought to realize gains throughleverage and achieve significant cost savings, particularly through aggressive procurementrationalization and jettisoning IBM’s expensive back-office support such as call centers and humanresource functions.
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According to Morgan Stanley, IBM PC’s SG&A expense ratio of 10% issignificantly higher than the industry average of 6.8%.
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While TPG did not rely on potentialrevenue growth to justify the attractiveness of the carve-out opportunity, they did acknowledge thepotential upside of bringing focus to IBM PC’s consumer business in emerging markets.
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 The strategic rationale for the stand-alone carve-out opportunity holds for the Lenovo-IBMPC business combination and is further enhanced by the fit of the Lenovo and IBM PC businesses.Prior to the transaction, Lenovo was the undisputed leader in the China PC market with 27%market share, a low cost position that resulted in gross margins of 13.3% (versus 10% for IBM PC),
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Lenovo, December 31, 2004,
Circular; Very Substantial Acquisition Relating to the Personal Computer Business of  International Business Machines Corporation,
Hong Kong Stock Exchange, p. 149, p. 226.
4
William Grabe, interview by authors, December 6, 2005.
5
Winston Wu, interview by authors, December 6, 2005.
6
Victor Ma,
 Big is Beautiful,
Morgan Stanley Equity Research, April 19, 2005, p. 1.
7
Winston Wu, interview by authors, December 6, 2005.

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