Lenovo agrees to buy IBM's server business for $2.3 billion

Lenovo Group has agreed to buy IBM's x86 server hardware business and related maintenance services for US$2.3 billion, it announced Thursday.The deal encompasses IBM's System x, BladeCenter and Flex System blade servers and switches, x86-based Flex integrated systems, NeXtScale and iDataPlex servers and associated software, blade networking and maintenance operations. IBM will retain its System z mainframes, Power Systems, Storage Systems, Power-based Flex servers, and PureApplication and PureData appliances.Lenovo will pay $2.07 billion in cash for the IBM business unit, topping up its offer with shares.Although it is ranked as the world's largest PC vendor, Lenovo has seen demand for PCs shrink and has begun diversifying, developing smartphones, tablets and smart TVs to maintain revenue and earnings. Acquiring IBM's low-end server business will give Lenovo a new foothold in the enterprise hardware market, putting the Chinese PC maker in tighter competition with rivals Dell and Hewlett-Packard.In its home market of China, Lenovo has also found some success in selling servers. In 2012, the company partnered with EMC to sell servers and storage there.However, Lenovo has struggled to gain a footing in the international server market, said Rajnish Arora, an analyst with research firm IDC.Unlike its competitors, Lenovo has yet to establish strong ties with software makers such as Microsoft, Oracle or VMware to create an ecosystem around its servers, he said. Currently, HP, IBM and Dell lead the market, together accounting for over two-thirds of all server sales."The server business is not just about producing hardware at the lowest price point and selling it," Arora said. "You need to have a very robust ecosystem of solutions and partners that you can work with to drive the business."Lenovo's planned acquisition from IBM, however, will give the company added credibility among enterprise customers, according to analysts. In addition, selling servers is a higher-margin business than consumer gadgets.Due to its PC business, Lenovo possesses the manufacturing capability and the sales channels needed to sell servers, Arora said. But to compete with its rivals, Lenovo will have do more than just sell hardware, instead building solutions tailored for its enterprise customers."As long as they can think differently, I think they will become formidable competition in the server space," he said.If the deal goes through, Lenovo's planned acquisition will end up becoming the second time its bought a hardware business from IBM. In 2005, the company purchased IBM's ThinkPad division, which helped Lenovo expand in the business PC market.On Tuesday, IBM said that hardware sales fell 26 percent in the fourth quarter of 2013, compared to the same year-ago. Increased competition from low margin X86 server vendors was a factor, IBM said."IBM has not made very good margins on its low end servers for several years," wrote Jack Gold, of the analyst firm J.Gold Associates, in an email. IBM has too much overhead and not enough volume to compete with Dell and Hewlett-Packard, the two largest x86 server vendors.Lenovo has honed its computer manufacturing efficiencies and so could potentially squeeze more profit from server sales than IBM has not been able to do, he said.Lenovo "has really demonstrated their ability to scale out to the world in a high-volume business," said Tom Rosamilia, IBM senior vice president of the company's systems and technology group, in a press conference about the sale.Many of Lenovo's enterprise customers have been asking about the possibility of Lenovo supplying servers as well, said Peter Hortensius, Lenovo senior vice president, also at the press conference.The company does have a line of x86 servers already, but the IBM purchase will accelerate the company's plans to become a powerhouse in the industry. When the acquisition closes, Lenovo will move from being the sixth largest server vendor to the third largest, with 14 percent of market share, Hortensius said. It will enlarge Lenovo's business by a "factor of 10," he said."For us, it was a fast way to do something we were already planning to do. It gives us total end-to-end capabilities in development, sales, and ... a very strong supply chain that would, frankly, would take us five years to build up something similar," Hortensius said.The deal is also good for IBM in that "it allows us to focus our investments on high value segments for enterprise clients," Rosamilia said. IBM will also get increased exposure through Lenovo to the growing Chinese market for system sales.As part of the deal, IBM will provide Lenovo with the rights to resell, at the OEM or retail level, IBM entry and mid level Storwiz storage systems, as well as IBM's GPFS (General Purpose File System) and related software, allowing Lenovo to create bundled packages around the x86 servers. IBM will also purchase Lenovo x86 servers for its own system sales.IBM will continue to provide maintenance on behalf of Lenovo for the x86 servers, for the foreseeable future. "Customers will see very little if any change in terms of their maintenance and support delivery," said Adalio Sanchez, the IBM general manager for System x systems, during he press conference.The deal is expected to close within six to nine months, pending regulatory approval.