SPD4202

Mergers and Acquisitions

Group Project – A Case Study on Lenovo (2010)

1. Learning Objective

The objective of this group project is to enable students to develop professional skills and
techniques in analyzing corporate mergers and acquisitions in a team-based environment.
Students are required to group themselves into teams (i.e. 5 students in each group) and to
complete a case study according to the following specific requirements.

2. Background of Case Study

Each group is assigned to examine a contemporary case of mergers and acquisitions

concerning an emerging Chinese multinational firm called Lenovo. The background of the
case is related to a period of rapid growth and development of Lenovo based in China
emerging from the beginning of the new millennium. The senior management determined to
transform themselves into a major player in the global PC market through mergers and
acquisitions in 2004. IBM’s PC Division was found to be the ideal target and the acquisition
was fully completed by 2005.

3. Requirements

As members of a consultancy firm, your team is engaged to review the assigned case study on
Lenovo, a major player in the current PC industry. In particular, your team is required to
perform some research on the recent development of the industry as well as company itself in
relation to its latest strategic processes.

There are TWO key requirements of this group project. The first part requires some
background research on the PC industry and the post-merger performance of Lenovo through
reviewing its annual reports and any other business reports. The second part concerns about
the future strategic development of Lenovo and detailed financial analysis on another
potential acquisition.

Part 1: Understanding the Past (40%)

Lenovo announced to acquire IBM’s PC Division in 2004 and aimed to be one of the largest
PC companies in the world. Since the acquisition completed in 2005, there have been
changes in the external environment and new challenges for the industry. Provide your
performance analysis of Lenovo based on its annual reports and other financial or business
information before and after the merger. Discuss whether Lenovo’s merger with IBM has
been successful one so far. In particular, point out the business problems relating to its
performance, if any, as result of the merger. You should support your analysis with some
comparable ratios.

Part 2: Looking into the Future (60%)

Lenovo’s management has been approached by an investment banker about the potential
acquisition in a company from North America that produces smart phones with proven track
record. The target company is asking for a minimum amount of US$500 million cash in the

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bidding document. Based on initial financial analysis, the acquisition will allow Lenova to
increase free cash flow by US$48 million per annum with annual growth of 8% over the next
5 years and then slow down to 3% thereafter. The analysts expect that the equity risk
premium would be increased to 8.5% from the existing 6.5% due to risk involved with the
new acquisition.

However, an advisor to the CEO (Dr. SPEED) has urged the senior management to invest
US$360 million to invest in R&D of the next generation of tablet products (similar to iPAD).
Dr. SPEED suggests that with this R&D grant Lenovo could enable an organic growth
through new product development. It is expected the new products would enable generation
of US$28 million free cash flow per annum one year after the R&D investment. Such cash
flow will then maintain a growth rate of 12% for 4 years before slowing down to 8% in the
following 4 years, then 3% thereafter. In fact, it is expected the equity risk premium would
remain at 6.5% in this case.

For both cases, the risk free rate is assumed to remain at 3% whereas the beta should be 1.5.
For the cost of debt, its rate before tax should stay at be 7.5% for both scenarios. The
effective tax rate for the company is 30%. The company would continue to maintain a debt
ratio of 20% based on market value.

As management consultants of Lenovo, you are required to produce a report with in-depth
financial/valuation analysis using a financial model. The report should discuss which of the
two options above – acquiring the smart phone company in the US or investing in R&D for
new products would be preferred. In addition to the financial analysis, explain what other
important, relevant business factors would need to be considered before making the decision.

4 Presentation and full report

The length of the report should be in the range of 3,000 words including Tables but excluding
appendices and references. Each group is required to print the full names and student numbers
of your group members on the cover page of the report. The document should use font size
12, 1.5 line-spacing with page numbering. All references and sources of data and articles
must be acknowledged. The assessment of the report will also be based on the quality of the
overall reporting writing as well as validity and reliability of the overall research.

A hardcopy of the full report needs to be submitted at the beginning of the lecture on 25th
November 2010. Group presentations will take place on 25th Nov. and 2nd Dec. 2010. A
group’s presentation date will be based on a random draw. Each group should prepare a
powerpoint for the required presentation of about 25 minutes, followed by an Q&A session.
Professional attire is required. Another group not presenting will be selected to provide
critics on the presentation. Each group should also submit its powerpoint presentation in
hardcopy on the scheduled presentation date.

5. References

You are expected to perform relevant research and make use of Lenovo’s Annual Reports at
least between 2004 and 2009. In your reports, you are advised to use the Harvard (name and
date) short reference system for citations in the text with a detailed alphabetical list at the end
of the paper. For example 'Hamel (2000) suggests ...' or 'Nonaka and Takeuchi (1995) found
that ...' or 'A study of economic change (Nelson and Winter, 1982) has shown that ...'

References should be made only to works that are published or available through libraries or
institutions. Any other sources should be qualified by a note regarding availability. You are
required to follow the guidelines provided to you on referencing standard.

- End -

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