Blog

February 2, 2014
LENOVO’S $5B SHOPPING SPREE: STRATEGIC IMPLICATIONS FOR THE MARKET AND M&A STRATEGY

Chinese technology firm Lenovo has had a busy ten days, spending $5.2 billion to acquire two more American technology flagships-cum-cast-offs. Lenovo positioned these purchases in the context of its reputation for turning around around commodity hardware businesses whilst the vendors were U.S. giants de-emphasising their hardware businesses. The first of the two transactions – $2.3 billion for IBM’s low-end server business – built on the $1.75 billion purchase in 2004 of IBM’s personal computing division (including the Thinkpad line). The second was somewhat more surprising: $2.9 billion for the Motorla Mobility division of Google. These purchases were apparently negotiated concurrently, with neither IBM nor Google being aware of the other transaction until late in the process.

From an M&A practitioner’s point of view this pair of transactions highlights two themes. Firstly Lenonvo’s patient pursuit of Mortorola Mobility underscores the value of communication, relationship-building and sustained focus on a desired asset.
The second lesson may be the effectiveness of Lenovo’s strategy of positioning itself as a trusted partner for both IBM (corporate relationships for servers and PCs) and Google (a friendly home for a major user of the Android operating system).

Lenovo has steadily scaled the computer hardware league tables, leveraging a global presence (via the first IBM deal) and a strong position in the Chinese market to become the largest vendor of PCs in the world (it surpassed Hewlett Packard to claim the top spot in 2012.)

Lenovo, however, has clearly realized that this was something of a Pyrrhic victory, for the PC market was – and remains – in decline (the market shrank 10% in unit terms in 2013). Concurrent with claiming the honours in the PC market Lenovo announced a strategic plan to broaden the company’s product offerings into adjacent areas: namely smartphones (increasingly used to access data) as well as other devices.

Lenovo may therefore be viewed as racing to broaden its portfolio ahead of declining markets. Whilst the x86 low-end servers produced by this IBM division (and rivals) are increasingly being displaced by higher-capacity servers, this market segment is farther from a tipping point than is the case with PCs. Smartphones are naturally in a more advantageous position.

Emerging from these deals Lenovo will be number three in the handset market behind Samsung and Apple. It will continue to partner with Google on the Android mobile operating system, though Lenovo (which intends to keep the Motorola Mobility brand running alongside the Lenovo smartphone marque, at least for now) is open to working with other suppliers of operating systems. Lenovo seems quite happy about Motorola Mobility’s relationships with almost five dozen major global wireless operators.

The Motorola Mobility deal also marks a substantial assault on the strategy of integrating hardware and software under one corporate roof. Apple had been the progenitor of this approach, with a design-led strategy integrating various devices with an operating system and an online delivery shop (iTunes). The Google/Motorola deal and Microsoft’s more recent purchase of Nokia’s handset unit were of a piece with this.

Lenovo’s view is that they have a profound understanding of the hardware business – more specifically the low-margin commodity hardware business – and that they are therefore better equipped to manage these businesses than any firm with a genealogy in software.
Background discussion to the deal announcement suggested that Lenovo had originally investigated Motorola Mobility at the time of the original transaction, had balked on price terms and had kept in frequent contact with Google thereafter. This autumn, bruised by ongoing losses and persistent questioning on analyst calls and in investor meetings, Google’s leadership reached out to Lenovo to initiate a more meaningful dialogue about the mobility unit. Put another way, Lenovo was not willing to meet Motorola’s original price but decided to hang around, hoping to purchase the asset on the rebound (as it were).

The commentary from both IBM and Google also highlighted the value placed on Lenovo as a reliable partner and custodian of relationships (with corporations, mobile carriers etc) of importance to the vendors.

That said Lenovo’s biggest risk may not be market change and disruption, but integration. These are two substantial deals, either one of which could keep a leadership team busy for the foreseeable future.

Consider the challenges facing Motorola Mobility. This division reported operating losses of $384 million in Q4 2013. It had, under the team appointed by Google, elected to produce a more limited range of handsets (at the time of the original deal the Google veteran appointed as the unit’s CEO remarked “Our aim is simple: to focus Motorola Mobility’s remarkable talent on fewer, bigger bets…”). This narrower range had not sold as robustly as had been hoped. It will be intriguing to see how this struggling division is turned around even as synergies with Lenovo’s existing, China-centric smartphone unit are sought.

It will also be worth watching what governmental scrutiny these transactions will draw. Sino-American relations are fraught – with Chinese moves on the geopolitical chessboard in the South China Sea alarming U.S. allies even as revelations regarding U.S. and Chinese cyber-espionage grow more widespread. Both deals will require formal review, and it is not clear that one or both of these deals will not draw hostile attention from some part of the executive or legislative parts of the U.S. government. Indeed attention to the ownership of a buyer is becoming a critical element in choosing what counterparty to sign exclusive terms with: in Canada two recent deals in telecommunications (Accelero’s mooted purchase of MTS Allstream and Vimpelcom’s proposed purchase of all of Wind Canada) were blocked on national security terms after definitive terms had been signed.

Another aspect of the conversation around the Motorola Mobility deal is whether this represents something of a defeat for Google. Google’s headline purchase price in May 2012 was $12.5 billion and Lenovo is paying only $2.91 billion.

At the time CEO Larry Page revealed “I’m happy to announce the deal has closed. Motorola is a great American tech company, with a track record of over 80 years of innovation. It’s a great time to be in the mobile business, and I’m confident that the team at Motorola will be creating the next generation of mobile devices that will improve lives for years to come.” Given these lofty objectives, and given the much lower sale price, some observers rushed to assert that Google had destroyed $9.6 billion of value.

This math is inaccurate and unflattering to Google in that a primary – but less widely discussed – objective of the Motorola Mobility deal had also been to bulk up Google’s patent armoury for what was, at the time, a battle royal amongst mobile operating system vendors. Patents were (and are) used to frustrate the launch or sale competing devices (Apple versus Samsung being a prominent case in point). The terms of the deal allow Google to retain upwards of 85% of the 17,000 Motorola patents acquired in 2012. At the time of the purchase Google valued these patents at approximately $5.5 billion (a not unreasonable number given that Nortel’s patent sale to Microsoft, Apple et al netted $4.5 billion).

Another point is that the original deal also brought Google cash and tax credits (about $1 billion worth of the latter), which dropped the original price (though some of this was clawed back with operating losses).

Finally Google sold the Motorola set-top box unit to Arris for a shade under $2.5 billion.

On this basis – and a current valuation of the patents is an important component of this calculation – it is arguable that the hit to Google was actually relatively small. The Google that emerges from this is more focused on its roots in web-based services and software and a clearer strategic distinction has been drawn between it and the integrated routes being pursued by Apple and Microsoft.