Are Lenovo and IBM Finally Close to Another Deal?

A deal for the x86 server business could be a win-win for Lenovo and IBM.

Jan 22, 2014 at 7:30PM

It has taken a long time, but Lenovo (NASDAQOTH:LNVGY) and IBM (NYSE:IBM) may be about to finally strike a bargain for IBM's x86 server business. Lenovo has openly acknowledged its interest in this business, but the companies have been at odds on deal terms. With ongoing share loss in the server business and a desire to reallocate capital to higher-returning businesses like software and services, IBM would do well to close this deal.

The good news for Lenovo is that it can do well with or without IBM's server business. The company has built the No. 1 PC business in the world and has already grown its tablet and smartphone business to be No. 4 in terms of market share, without aggressively targeting the U.S. Lenovo looks meaningfully undervalued, and sealing a deal with IBM would only help matters.

More than just talk this time?
Lenovo and IBM have been dancing around the issue of IBM's low-end x86 server business for some time, with Lenovo openly acknowledging in the past that it would like to acquire this business and use it to grow its own enterprise business. Supposedly, the companies were close to a deal last year, but talks broke down with the companies still $1.4 billion apart on the price. 

Since then, conditions in the x86 server business have deteriorated for IBM. The company has not been reinvesting in this business and its share, according to Gartner, has dropped by over six points since 2011. With System X sales down another 16% in the fourth quarter of 2013, things aren't getting any better at IBM, and the company continues to lose ground to Dell and Hewlett-Packard.

Now, it seems that both companies may be trying again. Lenovo issued a statement to the Hong Kong Stock Exchange noting that it was in talks for a potential acquisition, and IBM's x86 server business is the most likely candidate. If the rumors are true, the price for the business may end up in the range of $2.5 billion-$3 billion -- at least $500 million lower than the supposed low end of Lenovo's offer last year.

Will Lenovo spin gold out of IBM's straw?
Readers may remember that Lenovo bought IBM's PC business in 2005, and Lenovo has leveraged that acquisition to become a significant player in the global PC market. Even now, Lenovo's share of the U.S. commercial market is meaningfully larger than its overall U.S. share (by about three percentage points).

Lenovo should be able to do the same with the IBM server business. As this hardware business offers sub-optimal returns on capital, relative to IBM's other businesses, management has been making the very reasonable decision to under-invest in it, which has only exacerbated the share loss problem. Lenovo's business model is based around much lower margin assumptions, though, and Lenovo can use that to generate better returns on (and from) this business. In other words, it not only makes sense for IBM to jettison this business, but it also makes sense for Lenovo to acquire it.

At some point, though, the underinvestment in IBM's x86 business is going to reach a critical point. Clearly, IBM has been holding out for the best return possible, but Lenovo won't buy the business if it's no longer viable. At this point, though, Lenovo can still leverage IBM's server business across its existing enterprise business (particularly in China) and drive a market share recovery.

A "nice to have," not a "must have"
Lenovo could see 12%-20% earnings accretion three years after buying IBM's server business. Even without the deal, though, Lenovo has a lot going for it. The company has emerged as the No. 1 PC share-holder in the world and continues to gain even more share in the U.S.

Lenovo is also doing well with it's "PC+" strategy, following up on its PC success with new smartphones and tablets. With only a token presence in the U.S., Lenovo has the fourth-largest smartphone business in the world (behind Samsung, Apple, and Huawei) and the fourth-largest tablet business as well (behind Apple, Samsung, and ASUS). Thus far, Lenovo has focused on establishing a strong presence in emerging markets like Brazil, Russia, India, and Indonesia, but has also, reportedly, considered using M&A to accelerate its growth in the U.S.

Without IBM's server business, expect mid single-digit revenue growth from Lenovo and slightly higher free cash flow growth. Even at an elevated discount rate, that supports a fair value above $31 today.

The bottom line
Lenovo has been building its own server business (holding about 6% share in China), but finally sealing the deal for IBM's unit would be a big step forward. At a price below $3 billion, Lenovo will have a major win. At a price below $4 billion, Lenovo will still have a worthwhile and accretive transaction. However, Lenovo may find it challenging to manage a dual focus on growing its enterprise and consumer-oriented businesses. This is a good problem to have, and I believe Lenovo remains an undervalued share-gaining play in the global PC and mobile device market. 

Profit from the evolution of technology
Opportunities to get wealthy from a single investment don't come around often, but they do exist, and our chief technology officer believes he's found one. In this free report, Jeremy Phillips shares the single company that he believes could transform not only your portfolio, but your entire life. To learn the identity of this stock for free and see why Jeremy is putting more than $100,000 of his own money into it, all you have to do is click here now.

Stephen D. Simpson, CFA owns shares of Lenovo. The Motley Fool owns shares of International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers