Lenovo eyes acquisition of IBM's x86 server business

Here's what's in store for the group.

According to maybank Kim Eng, Lenovo is negotiating with IBM to acquire IBM's x86 server business. 

Maybank noted that it is positive on the potential deal if acquisition valuations are reasonable and equity dilution is kept to a minimum. We think the deal will complement Lenovo’s strategy of penetrating into the government and enterprises, especially in China.

Here's more:

We believe Lenovo will achieve better scale than IBM in component sourcing given the former is already a top PC vendor. The localisation of manufacturing and R&D (Lenovo already operates its own R&D lab) could generate cost savings, creating shareholder value over time.

Importantly, this deal would allow Lenovo to offer a complete IT solution for large/small enterprises and the government as Lenovo already commanded 15% market share of server market in China. In Dec 2012, Lenovo formed a JV and strategic partnership with EMC to provide servers and networked storage solutions.

At the same time, it acquired Stoneware for cloud computing solutions. We believe the localization of IT industry will further solidify Lenovo's market position.

The deal could be funded by a combination of cash, debt and equity. The amount of external funding required would depend on the acquisition price. Assuming a valuation of 1x P/S, System-X would be worth USD4b. Lenovo has a history of using equity to fund its acquisitions, but given its unleveraged balance sheet, the low interest rate environment and size of the deal, we believe debt funding would be a better option.

This could enhance its already impressive ROE of 25%.