Lenovo buys IBM server unit for $2.3 billion

Analysts don’t view the acquisition to be expensive but IBM's server unit's earnings have degraded in the past 12 months.

Lenovo, the world's largest PC maker, has struck a $2.3 billion deal to buy IBM’s server unit, reflecting the growing ambitions of Chinese companies to extend their reach.

The deal had been rumoured for some time but talks reportedly broke down last year due to disagreements over valuations.

In the end, the acquisition – which includes certain hardware products such as “Blade” and “System x” – was struck at a multiple of 12.3 times the unit's earnings for the financial year ended March 2013.

Lenovo is trading at a multiple of around 17.3 times its 2013 financial year earnings and about 15 times its forward earnings, so the acquisition looks accretive, according to Stephen Yang, an analyst at Sun Hung Kai Financial.

“It doesn’t look expensive to me,” said Yang. “But the problem is that IBM’s server business has been running at a loss for the past 12 months,” he said.

The server business made a net profit of $180 million in the 12 months ended March 2013 but a net loss of $37.4 million in the 12 months ended December 2013.

Analysts also cite increased competition from companies which source directly from original design manufacturers and from key rivals Dell and Hewlett Packard.

However, there are synergies to the deal as Lenovo doesn’t have a very large server business. “This deal puts them in a different league," added Yang.  "When a Fortune 500 company needs some sort of service, Lenovo would now be on the short list of guys they would consider,” he said.

This is the second time Lenovo is buying from IBM, having bought its PC unit in 2005 for $1.25 billion excluding debt. The server deal will be funded by $2 billion of cash and 182 million Lenovo shares.

Credit Suisse and Goldman Sachs advised Lenovo. Bank of America Merrill Lynch advised IBM.

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