Concerns mount over Lenovo's IBM deal

Lawmakers fear it could pose a threat to U.S. security

The acquisition of IBM's PC business by China's largest PC maker, Lenovo Group Ltd., may pose a threat to U.S. national security and deserves a closer review by the U.S. Congress and government agencies before a decision is made on whether or not to approve the deal, three U.S. lawmakers said this week.

Those concerns were set out in a letter yesterday to U.S. Treasury Secretary John Snow that was signed by three Republican congressmen: House International Relations Committee Chairman Henry Hyde, House Armed Services Committee Chairman Duncan Hunter and House Small Business Committee Chairman Don Manzullo.

Specifically, the congressmen worried that the $1.75 billion deal could transfer advanced technology and corporate assets to the Chinese government, along with licensable or export-controlled technology, and may result in certain U.S. government contracts involving PCs being fulfilled by the Chinese government, according to a statement released by the House Armed Services Committee.

Lenovo is a public company listed in Hong Kong. However, Lenovo's parent company and largest shareholder, Legend Holdings Ltd., is closely tied to the Chinese Academy of Sciences, a government institution that manages national scientific research efforts in China and is directly overseen by the State Council, China's highest administrative body.

"Given the important issues at stake, Congress and other federal agencies need more time to evaluate the process and provide comments on the sale," the congressmen said in the statement, noting that the Dec. 8 announcement of the deal occurred when Congress was not in session (see story).

In response, Angela Lee, a spokeswoman for Lenovo, said, "Lenovo continues to cooperate with the routine review [of the deal] by all regulatory bodies."

That may not be enough to avoid an extended review of the deal by the U.S. Treasury Department's Committee on Foreign Investment in the United States (CFIUS). The lawmakers' call for additional time to review the Lenovo deal now makes an extended review by CFIUS "very likely," said Helen Lau, an analyst at Celestial Asia Securities Holdings Ltd. in Hong Kong.

That doesn't bode well for Lenovo. There are several possible outcomes to an extended investigation, including U.S. government approval for the acquisition, Lau said. However, a more likely outcome, according to Lau, is that the government will allow most of the deal to go through but block the part that involves the sale of IBM's research and development operations. That would reduce Lenovo's ability to compete against rivals like Dell Inc. and Hewlett-Packard Co., which currently spend more on R&D.

"Without IBM's R&D support, it is hard for Lenovo to compete against Dell," Lau said.

Treasury Department officials weren't immediately available for comment.

Lenovo's acquisition of IBM PC's business wasn't expected to provoke a debate over U.S. national security. The initial reaction among analysts and users was generally positive. In China, the official People's Daily newspaper declared in an editorial that the deal was a cause for "unlimited reverie" and a "perfect combination." But concerns soon emerged.

Shortly after the deal was announced, Gartner Inc. said in a research note that the deal "makes sense for both companies." But it warned that disruptions were likely and advised ThinkPad customers to take advantage of the potential risks inherent in the deal and negotiate lower prices from IBM. They should also be prepared to switch vendors if IBM's responsiveness to their concerns dropped, it said.

"Most customers [in Japan] received the news with anxiety," said Kumi Shingyouchi, a senior PC analyst at IDC Japan, citing anecdotal evidence of purchasing managers who were considering switching vendors immediately after the acquisition was announced. These IT managers wanted to deal with IBM, not Lenovo, she said.

Japanese users aren't the only ones concerned. "Change always makes people nervous," said Philip Papadopoulos, a longtime ThinkPad user and the program director of grid and cluster computing at the San Diego Supercomputing Center. "My nervousness is that the vision of the ThinkPad will get lost in transition."

Papadopoulos said he will likely stick with Lenovo if it maintains the quality of the ThinkPad series.

Even if most customers opt to stick with Lenovo, the company is sure to lose some customers, said Marvin Lo, an analyst at BNP Paribas Peregrine in Hong Kong. "I think that's unavoidable. Some clients will obviously walk away from this deal, especially the U.S. government."

For its part, Lenovo wants to convince users that it can continue to offer high-quality products under the ThinkPad brand. "We believe that this deal will bring even greater value to IBM's existing PC customers," Lee said in a statement. The company declined requests to make executives available for comment.

"During the transition period after closing [the deal with IBM], we'll continue to provide world-class products and professional services," Lee said, adding that ThinkPad users will benefit in the long run from the economies of scale created by the acquisition.

That hasn't convinced some investors. Lenovo's stock price dropped by more than 20% after the deal was announced and has yet to fully recover. Investors are worried that Lenovo -- which does little business outside China and has never made a significant acquisition -- has agreed to pay too much for IBM's PC business. They also question whether Lenovo's management can succeed where IBM has failed, by bringing the business into profitability after several years of steep losses, Lau said.

Moreover, Lenovo's management may not be up to the task of transforming Lenovo from a Chinese company into a global operation, Lau said. "I'm not sure if they can handle the differences in culture and management," she said.

Some investors would be happier to see the IBM deal called off. Earlier this week, the Bloomberg news agency reported that CFIUS was likely to conduct an extended review of the Lenovo deal. That report tapped into negative sentiment surrounding the deal and sparked a strong rally in the price of Lenovo's stock price on Monday, said Lo.

"When they saw that the deal might not be able to go through, people actually clapped their hands," Lo said, noting that the stock price soon fell again.

Paul Kallender and Tom Krazit contributed to this report.

Copyright © 2005 IDG Communications, Inc.

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