Mergers and Acquisitions - Benefits of the Lenovo-IBM Takeover - Example

LENOVO-IBM TAKEOVER by Student’s Name Code + Course Name Professor University City/State Date LENOVO-IBM TAKEOVER Strategy The transaction between Lenovo and IBM was informed by a very sound industrial rationale. It was complementary in nature in terms of products, geographies, and functional strength areas. This created a number of win-win opportunities for Lenovo, which was buying and IBM, which was selling. Although they offered a wide opportunity for synergy of revenues, they felt hat the combination across borders was a cost play (Anslinger & Jenk 2004). IBM decided to spin out its personal computers division in 2004 after recording losses of more than $230 million in 2003. This required the parent company to infuse more than $ 980 as of mid 2014 from the parent company (London 2005). Additionally, the personal computers division had become an orphan within the larger organisation because it was not consistent with the company’s strategy of focusing on high margin service businesses and enterprises. There were initial interests to acquire IBM from financial purchasers such as TPG whose attraction to IBM was based on their desire to create the PC segment as an entity on its own (Ling 2005). The players who declared initial interest in IBM wanted to create gains by leveraging, which would help them achieve massive cost savings, especially through the process of intensive procurement rationalisation alongside the process of jettisoning the costly back office support that existed within IBM. TPG did not depend on the potential for revenue growth to justify the viability of the carve-out chance. The upside was focusing on the personal computer consumer business of IBM in emerging markets. The carve-out opportunity is the strategic rationale behind the business combination between Lenovo and IBM. This was enhanced further by the strategic fit of the PC businesses of the two companies. Before this transaction was effected, Lenovo was the leading company in the Chinese Personal Computer Market, commanding 27 percent of the market share. Lenovo strengths were in desktops and consumer markets that were growing very fast. For example, the total sales of its handsets grew by more than 100 percent in 2004. However, it did not have a global reach, appeal, and scale. IBM Personal Computers, on the other hand, was present in more than 155 countries around the world. IBM at that time was a leading innovator in the personal computers segment (Lau 2004). Furthermore, IBM owned a very strong brand, especially the “Thinkpad” within the laptop industry segment. Additionally, it had the capabilities in in-class service within the PC market. Unfortunately, IBM focus on the consumer market was weak. Its desktop market was also very weak. Furthermore, its reach and appeal in China was very low. Therefore, a combination between Lenovo and IBM would create the 3rd largest force in the personal computer market globally, which would enjoy an 8 percent share of the entire laptop, consumer and desktop segments, which would be supported by unprecedented sales across the world alongside marketing, customer support, infrastructure, and distribution (Lau 2005). For example, sales for the Lenovo-IBM combination outside china were expected to reach more than 72 percent of the total sales compared to the 2 percent for Lenovo while standing alone. The global infrastructure of the new entity would assist them to drive costs down because the combination would bring together a low cost base of manufacturing with a very efficient supply chain. After the merger, Lenovo became the leading PC maker in the Asia pacific region, controlling 47.2 percent of the regions market (Figure 1) The two parties made estimates that indicated that the combined entity would lead to a cost synergy of more than $150 million annually on savings made from procurement alone, because Lenovo would obtain better prices on a number of IT components such as Intel chips when it purchased in bulk (Hill 2004). These benefits would be improved further by the two companies sharing bets practices, consolidating vendor lists and increase in the use of parts that are standardized through consolidation of product lines. Figure 1: Asia-Pacific market share for PC makers in 2011 Source: “http://writepass.com/journal/2012/12/world-trade-organization-chinas-economy-will-deeply-and-broadly-get-involved-in-international-division-of-labor/” Regulatory China has made significant improvements within the development of a coherent regulatory framework for merger and acquisition transactions. These developments have widened the scope of the type of acquisitions that are permissible and highlight its commitment to honour its WTO mandate (Schneider 2010). However, these regulations have an adverse impact on mergers and acquisitions involving foreign companies (Levin 2005). For example, during the Lenovo-IBM transaction, there was a requirement that the foreign company must be listed on the stock exchange or be a public company. However, since the Lenovo-IBM transaction was a case of a Chinese firm acquiring an American firm instead of the other way round, the regulatory environment in China favoured the transaction (China Daily 2004). For example, the approval process was not difficult while the valuation requirements did not have an impact on the merged entity. Figure 2: Mergers and Acquisitions in China in the last 8 years Source: “www.zdbchina.com” The figure above shows how the rate of mergers and acquisitions in China has gone up in the last eight years due to the relaxation of regulatory rules by the communist government. This factor has made the Lenovo-IBM deal easier to undertake. Defense Tactics The Lenovo- IBM takeover was not hostile (Burt 2005). A hostile takeover does not require any approval. It is an acquisition or takeover of a company despite the unwillingness of its board and management to agree to it. If a suitor company makes an offer, and the target company rejects it, but the suitor continues to pursue it, the takeover that arises from such a situation is known as a hostile takeover. The acquiring company in most cases engages in proxy fights where it tries to persuade a simple majority of the shareholders to replace the management with a new one that is ready to approve the takeover (Sparkman 2009). Alternatively, the suitor company can buy enough stocks in the open market until it gains strength to effect change in management. In all the methods, the management puts resistance, but the acquisition is carried out despite the unwillingness of the management. However, the Lenovo-IBM acquisition was a friendly takeover with no defense tactics employed to derail the merger. A friendly takeover is a situation in which the management and board of a target company agree to a merger with another company (Stratford 2014). The acquiring firm makes a public offer of cash or stock. The management or board of the target firm approves the buyout terms in public. However, these terms may be subject to regulatory or shareholder approval. If the management or the board does not approve, the merger or acquisition cannot proceed. Valuation The two parties felt that the 1.25 billion dollars IBM valuation was justified. On the surface, this valuation appeared to be rich given the fact that IBM PC division had a negative income over the previous three years, however the valuation was attractive based from a fro forma basis perspective. Base case analysis shows that the two players came out at the same place. In the end, the two parties held that the failure or success of the takeover would be determined by the ability of the entity to deliver on its potential of cost saving. Financing The takeover was a big set of risks that created opportunities for participation of private equities. GA and TPG managed to demonstrate to Lenovo and the government of China that they were in a position to provide significant assistance in the navigation of the financial hazards of the takeover. This deal was an unprecedented. Before this transaction, all equity transactions in China, private in nature, were growth capital based with a deal size averaging $22 million. Successful deals focused on the exportation of successful models of business with a view of accessing the domestic market in China. However, this deal was motivated by the desire by Lenovo to find private equity partners who would provide experience and expertise that would be valuable to the company as it tried to expend globally. Additionally, Lenovo believed that if it involved three private equity firms, their investment thesis would be validated in a manner that enhanced its credibility within the capital markets across the world, which would in turn increase the potential of Lenovo being listed in the American stock exchange in years to come. GA was responsible for the provision of due diligence that would help Lenovo assess the opportunity provided by the IBM Personal Computers during the process of auctioning. It had an option of participating in the deal as one of the minority investors. GA had been in China for more than five years through their software and e-commerce company called Digital China, which was also a subsidiary of Legend Holdings, the parent company of Lenovo. GA helped Legend Holdings take Digital China to the Hong Kong stock exchange. This investment helped GA create a close relationship with Liu Chuanzi. Liu Chuanzi is the founder and chairperson of Legend Holdings. He reached out to William Grabe, who was a partner at GA and a former IBM executive. This ensured that GA helped in the evaluation of the personal computer business operated by IBM. After losing the auction for the personal computer division of IBM to Lenovo, TPG later worked close with Lenovo to offer its transactional expertise in worldwide private equities and operational knowledge in return for an opportunity to be a minority investor. Lenovo agreed to TPG investment in the transaction because it had a very strong reputation, and its operational focus would be an added advantage to the entity. Immediately after the closure of the deal, TPG sent one of its best supply chain experts to Lenovo to help in driving the initiatives meant to create operational efficiency. TPG and GA believed that participating in the transaction would earn them seven times more the money they had used to finance the takeover. Implementation At first, there was a big difference between the human resource strategies of both companies. Lenovo focused on internal training its talented staff. On the other hand, IBM focused on improvement. There was a big difference in the wages of IBM and Lenovo employees in similar positions. Lenovo did not alter the wages of the IBM employees for three years after the merger. It created a unified wage system, and maintained the executives and technicians who used to work with IBM, which was a source of competitive advantage for the company (Dickie 2005). Secondly, Lenovo was able to resolve the problematic issue of blending the two different brands. IBM had a powerful brand rank while Lenovo did not any significant reputation globally before the takeover. To avoid hurting IBM’s reputation, Lenovo used a co branding strategy with the personal computer division of IBM, allowing Lenovo to use IBM trademarks for a limited period. The buffer time of 5 years helped Lenovo boost its popularity worldwide. It is now one of the most reputable brands worldwide after riding on the brand advantage offered by IBM after the merger. Deal Risks Most mergers and acquisitions destroy shareholder value, especially when not implemented carefully. The Lenovo takeover of IBM faced two major risks. The most pertinent risk is the operation and cultural integration. This had the capacity to derail this takeover. Lenovo and IBM came from two different countries with distinct cultures (China Daily 2005). The organisational cultures of both companies were also very dissimilar. IBM had a western mindset while Lenovo had a Chinese one (Dickie 2005). Furthermore, IBM personal computer division had operated at a loss for several years. Lenovo did not have any experience of operation outside China while IBM was present in more than 155 countries. This meant that the western management would run the international business of the entity in the international business because of their experience. However, there were fears that the Americans would leave because of the possibility of cultural clashes (Freeland 2007). Economists were worried that Lenovo could worsen the situation up because of the deep cultural divide between China and America. Furthermore, there was a wide gap in how IBM and Lenovo paid their personnel. Apart from cultural risks, there were potential operational risks during the integration. The task of subsuming a multinational with presence on more than 155 countries with a company that 3 times smaller and had presence in just a single country was not easy. Integrating the two companies in their original formats was difficult. Furthermore, the restructuring of the manufacturing functions and the supply chain was a significant addition to the risk (Dickie 2005). Execution of two significant cost initiatives important to the industry logic of the combination was very far from being assured. Leveraging on Lenovo’s low cost goals and getting preferential sales terms from a number of suppliers was a herculean task. Before this takeover, no Chinese company had managed to turn a loss making overseas venture into a profitable asset successfully (Praise 2011). This precedence means that Lenovo was swimming in very risky waters, economically. Another issue was what would happen next after the service agreements that Lenovo had negotiated with IBM disappear. There was an agreement on interim services that had allowed the combined entity to access the sales network, distributors, partners, warranty services, and financing arms that IBM had already established. The second risk that the deal faced was the competitive response risk. When the deal was implemented, there were fears that potential opportunistic response by market leaders, Hewlett-Packard and Dell would compound the impact of the uncertainties that the merger faced. The two market leaders were expected to target IBM customers after the announcement of the merger through to its close and integration. The ability of IBM to retain its customers after the merger was put in question by economists, especially within six months before the closure of the deal because HP and Dell would capitalize on any uncertainty among the customers of IBM products and seek them out aggressively (Hamm 2008). The deal was risky because the competitors were likely to tarnish the IBM brand as they tried to woo its customers. Additionally, IBM would be forced to cut its profitability by attempting to match the aggressive pricing of its competitors with a view of retaining its customers (Palmer 2006). Furthermore, there was a risk of combining the high-end brand produced by IBM with the lower end brand produced by Lenovo. There were questions of how IBM customers would react to the change in control. The IBM thinkpad was the hallmark of quality, and the fact that it was made in America gave it an advantage, even though most of the production process took place in offshore locations. Additionally, there was another degree of brand risk because five years after the takeover, Lenovo would not have any right to use the IBM brand. The fact that Lenovo did not have brand recognition outside China meant that it would spend more money than expected to promote the new brand as it anticipated the expiration of the five years it had the right to use the IBM brand. However, as fig.3 shows, Lenovo has been able to use the leverage it obtained from the IBM brand to climb to the top of the worlds PC market, closing the gap with the leading PC maker, Hewlet Packard Figure 3: Lenovo position in the world PC market as of 2012 Source: “www.reuters.com/lenovo-closes-gap-with-world-no-1-PC-maker-HP” Reference List Anslinger P & Jenk J 2004, ‘Creating successful alliances’, Journal of Business Strategy, vol.25, no. 2, pp. 18-22. 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