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Samuel J. Palmisano, above, pursued a sort of personal diplomacy with Chinese officials on I.B.M.'s behalf. Below, Stephen M. Ward Jr., an I.B.M. executive who will lead the Lenovo PC business, with Fran O'Sullivan, general manager of I.B.M.'s personal systems group.

December 13, 2004

I.B.M. Sought a China Partnership, Not Just a Sale

By STEVE LOHR

In July 2003, Samuel J. Palmisano, the chief executive of I.B.M., traveled to Beijing to explore the sale of the company's personal computer business. But he did not start by making the usual visit with executives of I.B.M.'s preferred partner, Lenovo, China's largest personal computer maker.

Instead, Mr. Palmisano first engaged in a bit of old-fashioned courtship. Before formally approaching Lenovo, he sought permission from the parents, by meeting privately with a senior Chinese government official in charge of economic and technology policy.

I.B.M. was not merely looking to sell its PC business, Mr. Palmisano told the official, but had bigger aspirations of creating a global enterprise, with I.B.M. contributing technology, management, marketing and distribution.

The idea, Mr. Palmisano explained, would be to build a modern and truly international Chinese-owned corporation. The move, he added, would demonstrate China's desire to take that next step toward economic maturity by investing abroad instead of merely serving as a manufacturing hub for the rest of the world.

The senior Chinese government official, Mr. Palmisano recalled, responded, "That is the future model for where we see China headed."

Permission was granted.

Inside I.B.M., the issue of whether to stay in the personal computer business has been debated for a decade. But the road to the Lenovo deal, according to I.B.M. executives, began in 2000, shortly after Mr. Palmisano became the company's president and chief operating officer. He ordered an extensive review of the PC business and decided to stop selling I.B.M. PC's through retail stores.

At about that time, I.B.M. approached Lenovo for the first time, according to a person close to Lenovo, seeking to sell its PC business for $3 billion to $4 billion. At the time, I.B.M. had let its investment bankers know that if an attractive offer came up for the PC business, it would certainly consider a sale. But I.B.M. executives say that any discussion in 2000 was probably a prospecting overture by an outside adviser representing the company.

In May 2002, Mr. Palmisano directed John Joyce, then I.B.M.'s chief financial officer, to meet with Lenovo's senior management to sound out the company's interest in establishing a business relationship. Lenovo, according to I.B.M. executives, was intrigued and had long been exploring ways to increase its international presence.

More than a year later, at the meeting in Beijing, the government official told Mr. Palmisano that a few years earlier the Chinese authorities would have been involved in such talks. But times had changed, the official said, and Lenovo and I.B.M. could negotiate by themselves.

By October 2003, I.B.M. resumed discussions with Lenovo. In March 2004, Mr. Palmisano went to Beijing to meet with Lenovo's founder, Liu Chuanzhi, as well as its president, Yang Yuanqing, and the chief financial officer, Mary Ma. That was when Mr. Palmisano fully described what he had in mind. "I put it all on the table," he said.

Lenovo was definitely interested, though any such deal would be complicated. Many of the essential elements of the deal were hammered out over eight days in June, in a hotel near Raleigh, N.C., where I.B.M.'s PC business is based. The principal negotiators included Mr. Joyce, who now heads I.B.M.'s services business, Stephen M. Ward Jr., an I.B.M. executive who will become chief executive of the Lenovo PC business, and Mr. Yang.

There were other interested bidders, including one from an American buyout firm whose offer remained on the table until the end. And the Lenovo deal could have fallen apart. But apparently the Chinese option was the only one seriously pursued by I.B.M.

"There were simpler transactions we could have done," Mr. Palmisano said, adding, "What we wanted was not a divestiture, but this strategic relationship with Lenovo and China."

The sale of I.B.M.'s personal computer business to Lenovo for $1.75 billion, announced last Tuesday, is "a three-dimensional deal," according to Mr. Palmisano. The sale provides I.B.M. with a path to leave a business that is large but not profitable. It is also the latest step in I.B.M.'s shift toward services, software and specialized hardware technology from mainframes to microprocessors for computer game consoles, all of which promise higher profits than the fiercely competitive PC business.

Yet the most intriguing, and potentially most important, dimension of the deal for the company is that it is I.B.M.'s China card. The new Lenovo, folding in the I.B.M. personal computer business, will be China's fifth-largest company, with $12.5 billion in sales in 2003, and the Chinese government will remain a big shareholder. I.B.M. is eager to help China with its industrial policy of moving up the economic ladder, by building the high-technology engine rooms to power modern corporations and government institutions with I.B.M. services and software.

The deal is not expected to face any regulatory hurdles. Although there is a requirement, dating back to the era of the cold war, for review of possible national security implications, officials in Washington told I.B.M. executives in advance of the announcement that clearing it would not be a problem.

The pact could give I.B.M. "an extremely important leg up in China," Laura Conigliaro, an analyst with Goldman, Sachs, whose investment banking arm advised Lenovo, wrote in a report last week. "Ultimately, this is the single most valuable benefit to I.B.M. from this transaction."

The payoff for I.B.M., if any, will come gradually. The Lenovo deal, in which I.B.M. will take an 18.9 percent stake in the Chinese company, is a sign of I.B.M.'s commitment to China. I.B.M. is placing 10,000 of its employees, its brand for five years and some its prestige in Lenovo's hands. There is a lot more at stake than the $1.25 billion in cash and stock Lenovo is paying, and $500 million in debt obligations it will assume.

In China, I.B.M. is using a variation of the globalization formula that has worked well for it in Japan, Europe and elsewhere. I.B.M. patiently nurtures close ties with the government and becomes a premier employer and a stellar corporate citizen - so much so that it is eventually regarded more like a local company than an outsider.

"We don't have any special deal with the Chinese government or any other government really," Mr. Palmisano explained last week over lunch at I.B.M. headquarters. "It's a much more subtle, more sophisticated approach. It is that if you become ingrained in their agenda and become truly local and help them advance, then your opportunities are enlarged.

"You become part of their strategy," he added.

I.B.M. is no newcomer to China. It set up a business there 20 years ago, and there are now 4,200 I.B.M. employees in China. In 1995, the company opened a research laboratory, which now employs 150 Chinese scientists. Five years ago, I.B.M. established a Chinese software development lab, which today has 500 engineers working on Linux projects alone. (I.B.M. is the leading corporate supporter of Linux, a free operating system that is an alternative to Microsoft Windows.)

With the Lenovo deal, I.B.M. is forging even closer links with China. While there were other offers for its PC business, Mr. Palmisano pushed hard for this deal - more a bridge to another economy than a simple sell-off.

Mr. Palmisano, 53, who became chief executive in 2002, is the leader of a generation of executives groomed to run a corporation that is based in the United States but gets the majority of its revenue abroad, as I.B.M. does today. Traveling extensively is part of the regimen, as are stints of living abroad.

Mr. Palmisano managed I.B.M.'s large business in Japan in the early 1990's. He traveled extensively in Asia, including China, and continues to do so as chief executive. He makes three or four trips a year to China on business, and last summer he spent two weeks traveling across the country with his four children. "It was so they could get a feel for the Chinese culture and what's going on there," he said. "China is going to be such a huge influence in the world in their lives."

I.B.M.'s departure from the personal computer industry, Mr. Palmisano insisted, does not mean that the PC business is a bad one. But it does signal that it is no longer crucial to I.B.M.'s strategy of emphasizing services, software and server computers for corporate customers.

In an e-mail message to employees last week, Mr. Palmisano explained how the company's strategy and the PC business had parted ways. Today, there are two ways to create long-term value for information technology customers and shareholders, he wrote: "Invest heavily in R.& D. and be the high-value innovation provider for enterprises, or differentiate by leveraging vast economies of scale, high volumes and price."

I.B.M. is choosing the first path, and has decided that the PC business is inevitably on the second path.

David Barboza contributed reporting from Beijing for this article.

Copyright 2004 The New York Times Company