IBM is quitting its original role in the Lenovo Group. How can Lenovo overcome the fallout from this break-up?

In February, 2007, IBM sold 3.5% of its stakes in Lenovo and raised HK$960 million (US$123 million) with its sale of 300 million shares of Lenovo at HK$3.20 apiece. IBM's stake in Lenovo has been reduced to 11.5% after this most recent sale.

The first time IBM sold Lenovo shares was in July of 2005. Under the original deal, IBM held an 18.9% stake in Lenovo that could only be sold in stages over a three-year period. Last year, Lenovo signed on to new terms allowing IBM to sell its shares more quickly; under these new terms, IBM can sell as much as 2/3 of its stake beginning May 25th, and the balance after November 1, 2007.

An analyst with Gartner Inc said that after Lenovo acquired IBM PC, IBM promised to offer support to Lenovo's overseas business, and in return Lenovo would allow IBM to hold states in the company--a win-win situation for both. However, such relations have an expiration date, and Lenovo must be capable of taking over IBM's global support role, or its overseas business will be adversely affected.

Although Lenovo's executive director for Brand Communications in Greater China, Zhu Guang, emphasized that IBM is still optimistic about Lenovo's prospects, the analyst with Gartner suggested the opposite. "To a certain extent, IBM's sale of Lenovo shares reflects its attitude towards Lenovo. On February 1st, Lenovo's 2006 third-quarter finance numbers show little progress in its overseas business, which is a sign of whether the company can achieve successful internationalization. At the same time, Lenovo relies on IBM for overseas support. IBM's shrinking involvement is evidence of Lenovo's current situation."

When Lenovo acquired IBM's PC business, IBM agreed to provide support for branding and global operations. Apart from acquiring the permanent rights to the Think brand, Lenovo also acquired the rights to use IBM's logo on Think products for five years, and an agreement that, in order to fully integrate Lenovo's global IT system, IBM's IT system would offer support to Lenovo's overseas business. The most import support IBM brought to the table comes through its wholly-owned subsidiaries IGS and IGF. While IGS provides product quality warranty and after sales services for Lenovo products, IGF provides funding and financing channels for Lenovo's overseas channel partners.

Zhu explains that it is unlikely that Lenovo will build up its own global after sales services networks so shortly after the acquisition of IBM PC's business, and thus utilizing IBM's support network is the most economical option. When Chinese distributors obtain a large contract without the capital support to implement it, Lenovo generally offers the necessary capital and warranty support. However, Lenovo cannot yet offer such financial support to its overseas channels. This means that Lenovo cannot afford to lose the support of IGS and IGF.

Shortly after the acquisition, the Lenovo Group established a wholly-owned subsidiary in Singapore to be responsible for cooperation with IGS and IGF. In September of 2006 and January of 2007, IBM signed two separate service agreements with Lenovo, emphasizing the continuing support IGS and IGF provides for Lenovo. IBM's IT system would continue this support until 2013.

As soon as the acquisition was completed, Lenovo began constructing its own global IT system. The infrastructure is expected to cost US$200 million. Lenovo's global ERP system completed integration on October 1, 2006, but its after sales, supply and customer management systems were still operated by IBM's IT system. Lenovo president Yang Yuanqin said that the company would realize the global integration of all its IT systems in 2007.

Meanwhile, Lenovo has put considerable effort into building its global brand. The Lenovo Group conducted two large-scale branding campaigns to promote Lenovo and Think products, signing soccer star Ronaldinho during the 2006 World Cup, and cooperating with many gold medal winners from the Turin Winter Games. On February 4th, Lenovo announced its cooperation with F1 to promote the brand.

But how does the capital market view PC business? IBM's shrinking involvement reflects this market's attitude to a certain extent. According to IDC's global PC market quarterly report, global PC output increased by 8.7% to 65.6 million units in the fourth quarter of 2006, coming in below the 9.1% growth rate of the previous quarter, and 1.4% lower than industry expectations.

In 2006, annual PC output was 229 million units--an increase of 10% from the year before, but behind the 16% increase from 2004 to 2005, and .4% lower than industry expectations. HP and Acer are among the few PC makers to undergo ideal growth. Although Dell still ranks at the top of global PC makers in terms of output, its leading position has been challenged by HP. According to IDC's data, Dell's fourth-quarter output was 9.67 million units, compared with HP's output of 11.9 million. Lenovo's growth in PC sales volume was 8%, lower than the global average of 8.7%.

David Daoud, Research Manager at IDC's U.S. Quarterly PC Tracker and Personal Computing, commented that 2006 was a difficult year for global PC makers. "In the US market, home and commercial PC demands were weakened, shedding negative effects on Lenovo and Dell. In Europe, weakened commercial demands have obstructed the growth of Dell, Fujitsu, Siemens, and Lenovo. China is among the few markets that is still seeing stable growth in the home and commercial PC markets."

The Gartner analyst said that Lenovo needs to focus on achieving growth in the US market, for which it requires IBM's support in the short run. In the long run, Lenovo needs to optimize its overseas business structure and cost-effectiveness. Concrete business growth is the key to attracting institutional investors like General Atlantic, Texas Pacific Group, and Newbridge Capital LLC, who have all funded Lenovo during the past few years.