IBM Servers Drain Profits as Lenovo Gains Bargaining Power

Jan 22, 2014 5:04 pm ET

(Updates with closing share price in eighth paragraph.)

Jan. 22 (Bloomberg) -- International Business Machines Corp.’s server business is dragging down sales and profits, hurting the division’s value just as Lenovo Group Ltd. is said to be considering an acquisition of the asset.

IBM’s revenue declined for a seventh straight quarter amid plunging demand for its x86 servers. The slump weighed on the hardware unit, where profit slid $750 million in the fourth quarter from a year earlier because of “business model issues due to market shifts,” Chief Financial Officer Martin Schroeter said yesterday.

Lenovo, the world’s largest maker of personal computers, has resumed talks to acquire the x86 unit, a person with direct knowledge of the matter said this week. Discussions with Armonk, New York-based IBM had broken up in May over the price of the asset, then valued at $2.5 billion to $4.5 billion, and the unit’s performance has continued to decline since.

“This will increase Lenovo’s negotiation power over the price,” Jun Zhang, an analyst with Wedge Partners Corp., said in an e-mail.

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

While the division’s declining performance may help Lenovo win a better price, that will also depend on whether other bidders emerge for the assets, such as Dell Inc., Zhang said. The Wall Street Journal this week reported that Dell was looking at the IBM unit.

Other Headaches

The x86 division is only one of several headaches for IBM’s hardware unit. While x86 sales were down 16 percent from a year earlier, overall systems revenue declined 25 percent, including a 37 percent fall in mainframes and a 31 percent drop in servers based on IBM’s own Power chips.

IBM shares fell 3.3 percent to $182.25 at the close in New York, the biggest one-day drop since Oct. 17. They have fallen 7.1 percent in the past year.

Schroeter didn’t elaborate on the unit’s challenges during a conference call yesterday, or name any potential buyers for the server business. He said IBM will continue to dispose of some units.

“We’ll continue our transformation, shifting our investments to the growth areas and mixing to higher value,” Schroeter said. “We’ll acquire key capabilities, we’ll divest businesses, and we’ll rebalance our workforce.”

Jeffrey Shafer, a Lenovo spokesman, today declined to comment on Schroeter’s remarks.

Preliminary Talks

Lenovo said yesterday it’s in preliminary talks on a possible acquisition, without identifying the target or seller.

IBM is getting rid of businesses with lower profit margins and focusing on software and services to reverse declining sales. Lenovo, which began its rise to the top spot in the global PC market by acquiring IBM’s unit in 2005, is looking to counter falling industry shipments by expanding into storage equipment and the servers that run corporate networks.

Lenovo is only in talks to acquire IBM’s x86 server hardware business and not services, said the person with direct knowledge of the matter, who asked not to be identified because the talks are private. A deal may be signed within weeks, said the person, who didn’t provide details on the current price or structure of the proposed deal.

Lenovo, which has its headquarters in Beijing and Morrisville, North Carolina, plans to double its share of the server market within three years, and an acquisition could help speed that process, the company said in June.

Lenovo fell 1.3 percent to close at HK$10.32 in Hong Kong trading. The stock has gained 34 percent in the past 12 months, compared with a 2.4 percent decline in the Hang Seng Index.

--Edmond Lococo. Editors: Crayton Harrison, Nick Turner