Lenovo Group Ltd., the world’s largest maker of personal computers, agreed to buy International Business Machines Corp.’s low-end server business for $2.3 billion amid the PC industry’s worst-ever decline.

The deal price includes about $2 billion of cash and the rest in Lenovo stock, the companies said in a statement today. The purchase adds IBM’s business using x86 processors as well as System x, BladeCenter and Flex System blade servers and switches that run corporate computer networks.

Chief Executive Officer Yang Yuanqing has weathered the global PC industry slump and maintained growth by expanding his ThinkPad notebooks into markets across Europe and South America, while adding mobile devices. Now he’s pushing into a business with wider profit margins than PCs, and adding about $4.6 billion of annual revenue, by offering storage equipment and servers via Lenovo’s largest acquisition yet.

“This deal is relatively transformational for Lenovo,” said Alberto Moel, an analyst at Sanford C. Bernstein & Co. In Hong Kong. “If Lenovo can control expenses and enjoy some of the higher gross margins in this business, which are above Lenovo’s PC margins, then this could be a very good deal for them.”

Yang had been seeking to increase Lenovo’s share of the global server business to between 5 percent and 10 percent within three years. Today’s deal beats that goal by itself.

 

Market Boost

 

Lenovo will have about 14 percent of the market when the deal is completed, from less than 2 percent now, Senior Vice President Peter Hortensius said in a phone interview today.

The business Lenovo is buying makes IBM’s x86 servers, which are named for a chip design used by Intel Corp. and Advanced Micro Devices Inc. Servers have become a commodity amid increasing competition with companies such as Hewlett-Packard Co.

The deal marks the second time that Yang has looked to assets from IBM to spur his company’s growth.

Yang built Lenovo into the world’s largest maker of personal computers starting with the 2005 purchase of IBM’s PC unit for $1.25 billion, excluding debt. That transaction, the company’s previous largest, vaulted Lenovo from the No. 8 maker at the time to third. The company subsequently bought control of Germany’s Medion AG and NEC Corp.’s PC division in Japan.

 

Mobiles, Enterprise

 

Yang said he wants to build future growth on mobiles and enterprise, supplying equipment and services to corporate and government customers.

“For the past 20 years, PCs were our core business,” the 49-year-old said in a phone interview. “This deal will meet our strategy and give us a good foundation for the enterprise business. We hope we quickly can build it into $10 billion in annual sales, from $4.6 billion now.”

Lenovo and IBM last year held talks on the server business that broke down when they couldn’t agree on a price. Talks resumed in November, Chief Financial Officer Wong Wai Ming said in a phone interview.

Shares of Lenovo were halted from trade in Hong Kong today. The stock has returned 34 percent to investors, including dividends, in the past 12 months.

“Due to the strong IBM client base, Lenovo can enter the top-tier enterprise services market,” Tony Yang, a Hong Kong- based analyst at BOCI Research Ltd. in Hong Kong said in an e- mailed report. “We think the service business will be Lenovo’s major driver in the future.”

 

Dell, HP

 

Lenovo had net cash of $2.46 billion as of Sept. 30, the company reported in November. CFO Wong in October said the company could also finance a large purchase by issuing equity.

IBM was the third-largest vendor of x86 servers in the third quarter, trailing Hewlett-Packard and Dell Inc., according to data from researcher IDC. IBM’s $1.21 billion in such hardware revenue during the third quarter accounted for 13 percent of the total $9.52 billion in global sales during the period, according to IDC. Lenovo didn’t rank among the top 10.

Yang is looking for growth from servers as global PC shipments fell 10 percent in 2013, the worst decline, researcher Gartner Inc. said this month.

The previous acquisitions helped Lenovo overtake Hewlett- Packard for the top spot in PC shipments in the second quarter of last year. Lenovo kept that spot with 18.1 percent market share in the fourth quarter, helped by a 6.6 percent increase in shipments, according to Gartner.

 

IBM’s Focus

 

The sale would continue IBM’s campaign to get rid of businesses with lower profit margins, such as hardware, to focus instead on software and services. Since selling the PC division to Lenovo, IBM has also divested units such as printers and retail-store systems.

IBM on Jan. 21 said the server business was dragging down sales and earnings as the company’s revenue declined for a seventh straight quarter amid plunging demand for the x86 servers.

The slump weighed on the hardware unit, where profit slid $750 million in the fourth quarter from a year earlier, it said.

IBM will keep its System z mainframes, Power Systems, Storage Systems, Power-based Flex servers, and PureApplication and PureData appliances, it said.

The proposed transaction may trigger a U.S. security review that could slow or even scuttle the purchase as growing Chinese investment in the U.S. has prompted national-security concerns.

 

Security Review

 

Proposed transactions by Chinese companies accounted for about 20 percent of reviews in 2012 by the Committee on Foreign Investment in the U.S, supplanting the U.K. as the most- scrutinized nation. The panel consists of the heads of federal agencies including the departments of Commerce, Defense, Homeland Security, Justice, State and the Office of the U.S. Trade Representative.

Lenovo’s Hortensius said the company wouldn’t have done the deal if they didn’t think it would pass U.S. regulators, he said.

Even if the deal can clear regulatory hurdles, Lenovo could still lose some of IBM’s traditional customers in the U.S., though that could be offset by gains in its home market of China, said Stephen Yang, a Hong Kong-based analyst at Sun Hung Kai Financial.

“Lenovo may still face some headwinds selling servers to American institutions and corporates due to worries over counter-intelligence,” Sun Hung Kai’s Yang said before the announcement. “Lenovo would likely focus on growing its China market first, like they’ve always done with any business.”

 

--Edmond Lococo, with assistance from Brian Wingfield, Kasia Klimasinska and David McLaughlin in Washington, Alex Barinka in New York, Tim Culpan in Taipei and Jonathan Browning in Hong Kong. Editors: Robert Fenner, Aaron Clark

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