Case Study on Lenovo and IBM
Case studiy related to the PC Giant - Lenovo and IBM...
Harvard Business School
The Emergence of a Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division
A Final Paper Submitted to Professor Mihir Desai
John Ackerly Måns Larsson
December 2005 The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 1/28
Introduction On May 1, 2005, the Lenovo Group acquired IBM’s personal computing division (IBM PC) for $1.25 billion, achieving the goal of its ambitious founder, Liu Chuanzhi, to create a global PC manufacturing powerhouse. By transforming itself from an upstart company focused on its domestic market, Lenovo joined an exclusive club of Chinese companies, such as Huawei and TCL, which compete head-to-head with leading multinational corporations. Without the involvement of western private equity firms – Texas Pacific Group (TPG), Newbridge Capital,1 and General Atlantic Partners (GA) – this transaction may never have been consummated.
Each firm brought crucial expertise and credibility that helped mitigate the
significant financial, operational and cultural risks inherent in a large scale, cross-border transaction. Many believe that these efforts opened a new chapter in the growth of China’s economy and its integration with the West. As Bill Grabe, GA’s representative on Lenovo’s board, stated: “Lenovo’s acquisition of IBM mark the start of something bigger. In the future, we will see more Chinese global giants emerging through cross-border M&A.”2 This paper examines the underlying motivations and assumptions of each party in the transaction. While this transaction had many risks, we conclude that the strategic rationale was sound, the ultimate valuation was fair, and that all players are positioned to benefit: IBM shed a resource consuming, non-core asset; Lenovo leapfrogged to global leadership; and, the private equity players negotiated and structured a deal with significant upside potential with limited downside. The paper reaches these conclusions by answering four key questions: •
What was the strategic rationale for and key risks of the acquisition?
Why did the private equity buyers get involved in the transaction? What were the underlying motivations of the interested parties?
How was the deal structured to address the assumed risks?
How did Lenovo think about the valuation of IBM PC? What was the “fair” value of IBM PC at the time of the transaction?
Newbridge Capital is an affiliate of TPG. Hereafter, “TPG” will refer to Newbridge as well as the Texas Pacific Group. 2 William Grabe, interview by authors, December 6, 2005. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 2/28
SECTION 1: What was the strategic rationale for the acquisition and what were the key risks? Strategic rationale The Lenovo-IBM PC transaction was underpinned by sound industrial logic. The complementary nature of their businesses across geographies, products and areas of functional strength opened a number of win-win opportunities for buyer and seller. As outlined below, though the deal offered significant opportunity for revenue synergies, the cross-border combination ultimately was viewed as “cost play” by the parties involved. When IBM decided to spin out its PC division in April 2004, its motivations were clear: the division recorded a net loss of $258 million in 2003 and $171 million in 2002 and had required a total parent company equity infusion totaling $987 million as of June 2004. 3 In addition, the division was an “orphan” within the organization, as it did not fit within IBM’s broader strategy to focus on higher margin enterprise and services businesses. The initial interest in IBM PC came from financial buyers such as TPG who were attracted to the carve-out of IBM PC as a stand alone entity.4 These players sought to realize gains through leverage and achieve significant cost savings, particularly through aggressive procurement rationalization and jettisoning IBM’s expensive back-office support such as call centers and human resource functions. 5 According to Morgan Stanley, IBM PC’s SG&A expense ratio of 10% is significantly higher than the industry average of 6.8%.6
While TPG did not rely on potential
revenue growth to justify the attractiveness of the carve-out opportunity, they did acknowledge the potential upside of bringing focus to IBM PC’s consumer business in emerging markets.7 The strategic rationale for the stand-alone carve-out opportunity holds for the Lenovo-IBM PC business combination and is further enhanced by the fit of the Lenovo and IBM PC businesses. Prior to the transaction, Lenovo was the undisputed leader in the China PC market with 27% market share, a low cost position that resulted in gross margins of 13.3% (versus 10% for IBM PC), 3
Lenovo, December 31, 2004, Circular; Very Substantial Acquisition Relating to the Personal Computer Business of International Business Machines Corporation, Hong Kong Stock Exchange, p. 149, p. 226. 4 William Grabe, interview by authors, December 6, 2005. 5 Winston Wu, interview by authors, December 6, 2005. 6 Victor Ma, Big is Beautiful, Morgan Stanley Equity Research, April 19, 2005, p. 1. 7 Winston Wu, interview by authors, December 6, 2005. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 3/28
and enjoyed particular strength in the desktop and fast growing consumer market. For example, its handset sales grew 100% in 2004.8 However, it lacked global reach and scale. IBM PC, on the other hand, operated in 160 countries across the globe, was a leading innovator, owned a strong brand – particularly “ThinkPad” in the laptop market – and boasted best-in-class service capabilities.
However, the division had virtually abandoned the consumer business, had a weak
desktop business and limited reach into China.
The business combination would create the 3rd
largest competitor in the PC market with 8% market share across the desktop, laptop and consumer segments supported by unparalleled global sales, marketing, distribution and customer support infrastructure.9 Sales of the combined group outside China were expected to be 72% of total sales, versus 2% for Lenovo on a stand-alone basis. The combined entity’s global infrastructure would help drive cost savings by marrying an efficient supply chain with a low cost manufacturing base. The parties estimated that LenovoIBM’s scale would create cost synergies of $150-200 million a year on procurement savings alone, as Lenovo could get better pricing on such components as Intel chips by purchasing in bulk.10 Analysts have estimated that these procurement savings account for 60-70% of total savings.11 These benefits would be further enhanced by sharing of best practices, consolidation of vendor lists, and increasing the use of standardized parts by consolidating product lines.
analysts estimate that Lenovo and IBM would be able consolidate 16 functional areas achieving savings of $10-30 million.12 As mentioned above, Lenovo, IBM and the private equity players also recognized the potential for revenue synergies. Particularly attractive to Lenovo and the private equity investors was the opportunity to sell Lenovo’s low cost consumer products in emerging markets through IBMs extensive distribution network.13 In addition, TPG was optimistic that Lenovo would be able to take market share from Dell and HP in the U.S. consumer market.14 Finally, IBM PC traditionally sold its PCs to its IBM parent at cost. Under the terms of the deal, Lenovo would be able to achieve attractive margins on computers sold to IBM. 8
William Grabe, interview by authors, December 6, 2005. Lenovo, December 31, 2004, Circular; Very Substantial Acquisition Relating to the Personal Computer Business of International Business Machines Corporation, Hong Kong Stock Exchange, p. 149, p. 48. 10 The figure assumes that Lenovo-IBM could get similar terms to Dell and H-P. 11 Max Chen , interview by authors, December 1, 2005. 12 Max Chen , interview by authors, December 1, 2005. 13 William Grabe, interview by authors, December 6, 2005. 14 Winston Wu, interview by authors, Cambridge, MA, December 7, 2005. 9
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 4/28
Deal risks This section highlights the key risks facing each party. While the industrial logic of the Lenovo-IBM PC was clear, the transaction was fraught with risk. Due to the complex, crosscontinental nature of the deal and the predictable political angst spurred by the announcement, the transaction left the involved parties exposed to significant financial, operational and reputation risk.
Cave-out risks Even on a stand-alone basis, the carve-out of IBM PC from IBM’s operations would pose significant challenges. According to Winston Wu, a member of the TPG deal team, “The carveout of IBM PC is the most complex carve out ever attempted by a private equity firm”15 IBM PC was not organized as a separate stand-alone unit with its own functions within IBM. Rather, IBM PC benefited from centralized functions run by its parent, such as global procurement, sales and distribution as well as back-office support such as accounting, finance and human resources. These intricate links with the parent company added to the difficulty of structuring a share purchase agreement. In order to solve the issue of the IBM PC’s deep dependence on IBM, the transitional services agreements became important components of the negotiations and the transaction. This paper looks at these agreements in some detail in Section 3 below.
Lack of financial transparency The dependence of IBM PC on its parent also made it difficult to fully understand its “true” underlying financial performance.
According to PriceWaterhouseCoopers: “The historical
financial statements may…not reflect the results of operations, financial position or cash flows that would have resulted had the [Company] been operated as a separate entity.”16 For example, as discussed above, IBM PC is using its parent’s sales force and distribution channels and relies on its corporate functions. While IBM PC had historically paid its parent for many of these services, it is unclear if the prices paid represented “fair market” prices.
Financial dependence of IBM PC on its parent 15
Winston Wu, interview by authors, Cambridge, MA, December 7, 2005. PriceWaterhouseCoopers, “Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors of International Business Machines Corporation,” as reprinted in Circular, p. 115.
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 5/28
IBM PC relied on its parent for customer financing. IGF, IBM’s financing arm, originated commercial loans to finance dealer and remarketer purchases of the Company’s products to the tune of US$6.7 billion and US$6.0 billion in 2003 and 2002, respectively. These loans represent over 60% of the Company’s sales. Again, ensuring that IBM PC continued to receive these financial services became a significant issue in the negotiations. Similarly, as a part of the IBM group, IBM PC had access to its parent company’s war chest, which was an essential tool in managing the cyclicality of the business. IBM PC had tremendous intra-quarter working capital swings which approached 10% of annual sales. According to TPB, “[IBM PC’s] intra-quarter working capital swings could be as large as US$1 billion.”17 A big worry for the parties involved in the transaction was to what extent the Company would have sufficient cash and/or credit lines to manage these working capital movements.
Integration risks: cultural and operational In addition to the issues specific to a carve-out from IBM, the combination of a Chinese and U.S. firm posed a host of additional risks.
For example, the cultural and operational
integration challenge was significant and could have potentially derailed the deal.
companies had distinct cultures: IBM PC was an established global business with a Western management mindset, whereas Lenovo was a purely China-focused company run by local Chinese entrepreneurs. Further, according to IBM accounting, its PC division had been operating at a loss for years. Lenovo’s management had very limited experience operating outside China, and there was a risk that the key US management needed to run the international portion of the combined business might leave because of potential cultural clashes. As the Economist noted, “Lenovo might make things worse, given cultural differences between Americans and Chinese, big differences in pay and the need for interpreters at every meeting.”18 Indeed, cultural differences have plagued Chinese-Western mergers in the past. Vincent Yan, finance director of TCL, which merged with the French television manufacturer Thomson, has admitted that “the cultural gap proved wider than expected.”19 The integration also presented several operational risks. It would not be an easy task to subsume a global icon operating in 160 countries within a company one third its size that operates 17
Ibid. “Champ or chump?,” The Economist, December 9, 2004, 19 Ibid. 18
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 6/28
in only one country. Not only would the challenge of combining the two businesses in their current format prove difficult, but also the planned restructuring of the supply chain and manufacturing added significantly to that risk. In particular, successfully executing two major cost initiatives fundamental to the industrial logic of the acquisition was far from assured. Achieving preferential terms from suppliers and fully leverage Lenovo’s low cost infrastructure to reduce the global operating costs very ambitious goals that had never before been attempted by a Chinese company.20 According to Jeannie Chung at CSFB, “so far, no Chinese company has successfully turned loss-making overseas assets into a profitable business.
Lenovo could hardly be an
exception.”21 An additional question was what would happen to Lenovo after the negotiated services agreements with IBM had disappeared. As this paper discusses in Section 3, the interim services agreements gave Lenovo-IBM PC access to IBM sales network, business partners and distributors as well as its financing arm and its warranty services.
Political risk When the deal was announced there was a loud cry by politicians in the United States. At the outset, there seemed to be a risk that the deal would not get approval.
Congressmen lobbied against the deal, claiming that it would “allow the Chinese government to acquire sensitive American technology, and potentially, use IBM’s facilities to spy for the Chinese armed forces.” 22 They cited the fact that the Chinese Academy of Sciences was a major shareholder of the firm. These very same Congressmen wrote to the Treasury Secretary, John Snow, to argue that “the deal may transfer advanced US technology and corporate assets to the Chinese government.” 23 While many viewed these activities as shrill political posturing, the Committee on Foreign Investment in the United States extended its routine 30-day investigation by 45 days to perform a more thorough investigation.
In addition to approval risk, the key players
were concerned that Lenovo-IBM PC would lose IBM PC’s U.S. government contract, which represented approximately 7% of total IBM PC sales.
Ibid. Jeannie Cheung, et al., Lenovo Group: Powering Up, April 12, 2005. 22 “I spy spies,” The Economist, ´February 3, 2005. 23 Ibid. 21
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 7/28
Competitive response risk At the time of the deal, the potential negative impact of these uncertainties were compounded by the likely opportunistic response by Dell and Hewlett-Packard, who likely would endevour to target IBM PC customers between the announcement the transaction and a successful close and subsequent integration. A.M. Sacconaghi at Sanford Bernstein Research argued that “the main issue in relation to the sale is the ability of [IBM PC] to retain PC customers, especially over the next six months, before the deal closes, as Dell and Hewlett-Packard will probably aim to capitalize on the uncertainty among IBM customers by aggressively seeking them out.”24 There was a significant risk that the IBM PC brand would be tarnished by the competition as they would try to “steal” the Company’s customers. In addition, by competing head to head with Dell and H-P, IBM PC might have to match aggressive pricing, thereby cutting into the firms profitability.
Brand risk Just like there was a worry that a potential political backlash in the US and an attack by IBM PC’s competition could negatively affect sales, there was a concern that the transaction would result in a degradation of the “ThinkPad” brand around the world. Indeed, there was a risk in combining the “high-end” IBM brand with the “lower end” Lenovo brand. How would consumers react to the change of control? IBM Thinkpad stood for quality and “made in America” (even though most production took place offshore even under IBM’s ownership). Furthermore, there was a second degree of brand risk, five years after the transaction when Lenovo would lose the right to use the “IBM” brand. Lenovo’s lack of brand recognition outside of China could require that it spend more than expected on marketing promote its brand in anticipation of the expiration of the five-year term.
A.M. Sacconaghi, et al., “IBM: PC Business Sale Immaterial But Risks ‘Growth Gift’ to Rivals,” Bernstein Research, December 17, 2004, p. 1. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 8/28
SECTION 2: How and why did the private equity buyers get involved in the transaction? What were the underlying motivations of the interested parties? Ironically, it was this set of complex risks that opened the door to private equity participation. GA and TPG were able to demonstrate to Lenovo and the Chinese government that they could provide crucial assistance in navigate the financial, operational and cultural hazards of the transaction. The deal was the first of its kind. Prior to the Lenovo-IBM transaction, virtually all private equity investment in China was growth capital transactions with an average deal size of $22 million.25 Successful deals tended to be focused on exporting successful U.S. business models to China in order to access the domestic Chinese market.
In contrast, this deal was driven by
Lenovo’s interest in finding private equity partners who could “…offer expertise and experience that are expected to be valuable to the Company” in its global expansion.26 In addition, Lenovo believed that the involvement of the three private equity firms would validate their investment thesis and enhance its credibility in the global capital markets, increasing the likelihood of a successful listing on US stock exchange in the future. GA provided due diligence assistance to help Lenovo assess the IBM PC opportunity during the auction process in order to win the option of participating in a potential deal as a minority investor.27 GA had been operating in China for five years through their investment in ecommerce software and services company, Digital China, a subsidiary of Lenovo’s parent company, Legend holdings. GA helped Legend spin out Digital China helped and take it public on the Hong Kong stock exchange. Through this investment, GA formed a close relationship with Liu Chuanzhi, the Chairman and Founder of Legend. Liu reached out to William Grabe, a former long-time IBM executive and partner at General Atlantic to ask GA to help evaluate the IBM PC business. TPG partnered with Lenovo later, after having lost the auction for the IBM PC division to Lenovo in December 2004. TPG offered operational knowledge, global private equity transaction experience and carve-out expertise in return for opportunity to become a significant minority 25
Guide to Venture Capital in Asia (2004). Lenovo, December 31, 2004, Circular; Very Substantial Acquisition Relating to the Personal Computer Business of International Business Machines Corporation, Hong Kong Stock Exchange, p. 149, p. 2. 27 William Grabe, interview by authors, December 6, 2005. 26
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 9/28
shareholder.28 In addition, TPG gained a deep understanding of the IBM PC business through six months of due diligence during the auction process. When it lost the auction, TPG approached Lenovo about joining forces through a minority investment. TPG was one of many players who asked to participate, but Lenovo readily agreed to TPG’s involvement because of TPG’s strong reputation as an operationally focused partner and its grasp of the IBM PC business. In fact, upon completion of the transaction, TPG inserted one of their supply chain experts into Lenovo with a direct report to their CEO to drive operational efficiency initiatives. GA and TPG believed that this transaction could ultimately return as much as seven times their money. Taking into account synergies, TPG estimates that it invested at a single digit EBITDA pro forma multiple.29 Importantly, GA and TPG/Newbridge were in agreement on the key governance issues and direction in which the firm needed to be taken. In particular, they presented a united front with Lenovo in sometimes heated deal structure negotiations around such issues as minority voting rights and board representation.
Winston Wu, interview by authors, December 6 2005. Winston Wu, interview by authors, December 6 2005. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 10/28
SECTION 3: How was the deal structured to address the assumed risks? Satisfying all parties proved difficult and demanded a complex deal structure. According to Andrew Right, a member of the Goldman Sachs team that advised Lenovo in the transaction: “This transaction stretched the negotiators on both sides of the table to the limit…the complexity of the deal forced us to be extremely innovative in the structuring of the transaction.”30 Also, given the sensitivity of the discussion some of IBM PC’s key managers were kept out of the negotiations in order for them to preserve a good relationship with their new colleagues at Lenovo following the transaction. The proposed new CEO of Lenovo-IBM PC, Steve Ward, “was kept out of the acrimonious negotiations in order to facilitate the post-merger cultural integration.”31
Original deal: pre-private equity involvement The private equity firms were not involved in the original deal agreed in December 2004. According to the original agreement, Lenovo would acquire the IBM PC business, including the desktop and notebook product lines, corresponding R&D and manufacturing facilities. The total consideration of the transaction was US$1.25 billion plus the assumption by Lenovo of approximately US$500 million of working capital related liabilities (not considered part of the enterprise value since the Company has negative net working capital). Lenovo would pay the consideration in US$600 million of equity and US$650 million in cash, resulting in an 18.9% ownership in the new entity for IBM. The cash consideration would be paid with US$150 million from internal sources and US$500 million from a bridge loan provided by Goldman Sachs.
Final deal: private equity firms get involved The original deal was changed quite dramatically when the private equity firms became involved in the spring of 2005. TPG and GA paid US$350 million in a convertible preferred equity instrument that upon conversion equaled 10.24% of Lenovo-IBM PC’s share capital. In addition, the private equity firms received warrants that if exercised amounted to an additional 2.63% of the firm’s fully diluted share capital.
Andrew Right, Q&A discussion after Lenovo-IBM presentation at HBS, November 21, 2005. Andrew Right, Lenovo-IBM presentation at HBS, November 21, 2005. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 11/28
As a result of the involvement of the private equity firms, IBM would get a larger portion of the consideration in cash and its resulting equity stake in the Company would be decreased from 18.9% to 8.8%. IBM got approximately US$800 in cash and Lenovo-IBM PC common shares representing a value of US$450 million, instead of US$600 million (based on the HK$2.675, the closing price of Lenovo’s shares on the last day of trading prior to the December 2004 announcement). Table A provides a summary of the pre- and post transaction ownership structure.
Table A: Pre- and post-transaction ownership structure
Lenovo, Proposed Issue of Unlisted Convertible Preferred Shares and Unlisted Warrants, March 30, 2005, p. 13. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 12/28
Economic terms and rationale of strategic investment by private equity firms The private equity firms structured their investment as a PIPE (private investment in a public entity) and got convertible preferred shares. The key terms of their investment were as follows:33 •
Consideration: US$350 million
Preferred shares: 2.73 million unlisted preferred shares equaling 10.24% of the Company on an as-if-converted basis
Key terms of the preferred shares: o 4.5% annual preferential cash dividend, payable quarterly o Convertible into 1,001.8 million common shares, at any time, at a conversion price of HK$2.725 o Redeemable after 7 years at a price equal to the stated value plus accrued interest o 12 months lock-up period
Warrants: in addition, the private equity firms got unlisted warrants giving them the right to subscribe to 237.4 million common shares
By investing in preferred shares, the private equity players gave themselves significant downside protection. In the case of a bankruptcy or liquidation, their stake (unless converted) would give them rights to any proceeds before the holders of common equity. Similarly, the warrants gave them a “booster” if Lenovo performed well. If they exercised the warrants, they would receive an additional ownership stake of approximately 2.63%. Of course, TPG and GA would only exercise the warrants if the share price exceeds the original share price since the strike price of the warrants is equal to share price at which they bought their equity stake.
Corporate governance The private equity firms, who typically only invest when can enjoy a control position, structured the deal to ensure they had a strong voice in any key decision made by Lenovo management. For example, while PE firms hold just over 10% of the economic ownership in the Company, they have the right to appoint more than 33% of the board (2 directors for TPG, 1 for GA and 1 independent director). 33
Ibid. and CSFB Research. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 13/28
Table B: Board Structure Lenovo-IBM PC's Board Composition and Representation Board Memebrs
No. of Seats
Lenovo Chairman (Yang Yuanquing) Lenovo (Steve Ward) Lenovo CFO (Mary Ma) Legend Holdings (Liu Chuanzhi) Legend Holdings (Zeng Maochao) TPG GA Independent Non-Executive Directors Total
1 1 1 1 1 2 1 4 12
% of Representation 8.3% 8.3% 8.3% 8.3% 8.3% 16.6% 8.3% 33.2% 100.0%
Source: Circular, CSFB Research
In addition, the private equity firms gained significant minority rights. The private equity firms were particularly concerned about having control over key management changes and acquisitions and disposals.34 According TPG, “having blocking rights for key decisions that could potentially change the future of the Company was essential for us, even though we did not have a majority equity stake in the business.”35 While not providing outright control, these key minority rights would allow the private equity firms to block any major decision that they viewed to be contrary to their interests.
Key issues in the share purchase agreement Given the intricate relationship between IBM PC and its parent, the share purchase agreement was carefully structured to handle the transition issues which we outlined in the “Deal Risks” section above. To handle the risks associated with legacy issues, IBM was responsible for warranty liabilities stemming from any computer sold before the transaction closing date. According to the publicly available summary of the share purchase agreement, “all warranty, enhanced warranty and maintenance obligations relating to or arising from the products sold or shipped by the business prior to the initial closing” will be excluded from the transaction. 36 Similarly, “all liabilities to the extent relating to or arising from any defect in the design, manufacture, quality, 34
Winston Wu, interview by authors, December 6, 2005. Winston Wu, interview by authors, December 6, 2005. 36 Letter from the Lenovo Board to the Shareholders, December 31, 2004, as reprinted in Circular, p. 13. 35
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 14/28
conformity to specification or fitness for purpose of any product sold and shipped by the business prior to the initial closing” would be paid by IBM37 In 2003, warranty claims cost IBM PC $200 million and they are expected to total US$250-400 million in both 2005 and 2006.38 The Transitional Services Agreement handled the issues related to the complexity of the carve-out. Since IBM PC was fully integrated with IBM’s other businesses it was not feasible for Lenovo to acquire all the assets from IBM. The Transitional Service Agreement ensured that IBM would provision services to allow for a smooth ownership transition. The Strategic Financing and Asset Disposition Services Agreement was structured to handle the financial dependence of IBM PC on its former parent. This agreement effectively allowed Lenovo’s customers to lease products through IBM’s financing arm. In other words, IBM will finance Lenovo’s customers’ purchases of its computers. This was extremely important for the deal, since, as we pointed out above, some 60% of all historical purchases were financed by IBM. To address the operational integration risks, the parties entered into the IGS Services Agreement39 and the Marketing Support Agreement. The GS Services Agreement ensured that IBM’s services arm provided after-sales service with global coverage for Lenovo-IBM PC’s customers. This was important and ensured that Lenovo-IBM PC maintained the “industry best award-winning warranty service to which IBM’s customers are accustomed” 40 “Under the Marketing Support Agreement, IBM PC will be able leverage IBM’s well established enterprise sales force and established global sales infrastructure, i.e. client representative teams, for a period of five years.”41 Again, these agreements were designed to allow for a smooth transition to the new owners, protected the business’s momentum, provided for a gradual and problem-free transfer of the customer relationships to Lenovo’s team. To avoid losing its key customer, IBM, to the competition, the Internal Use Purchase Agreement stated that Lenovo will the “preferred and nearly exclusive (95%) supplier for all personal computers purchased by IBM for its internal use or strategic outsourcing deals for a period of five years.”42 Finally, as highlighted above, to mitigate the significant brand risk IBM 37
Ibid. Winston Wu, interview by authors, December 6, 2005. 39 IGS is IBM’s global services business. 40 Circular., p. 50. 41 Ibid., p. 51. 42 Ibid., p. 51. 38
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 15/28
allowed Lenovo to use the “IBM” brand for a five year transition period and Lenovo would be allowed to keep the “Think” brand forever.
SECTION 4: How did Lenovo think about the valuation of IBM PC? What was the “fair” value of IBM PC at the time of the transaction? In this section, we value IBM-PC at the time of the original transaction based on assumptions we developed through studying public documents and though our discussions with individuals intimately involved in the transaction. While not willing to share their actual valuation models with us due to confidentiality issues, the key players in the transaction – including Bill Grabe, a Lenovo Board member, the Goldman Sachs deal team, and principals at both TPG and GA – shared their views on the company, its future prospects, and the key drivers of their valuations. All parties felt that the $1.25 billion valuation of IBM PC was a “good deal”. According to TPG: “While on the surface the valuation may seem rich given IBM PC’s negative net income, we felt we were investing at a very attractive valuation multiple on a pro forma basis.” On the base case analysis, all players came out at a similar place. Ultimately, the parties believe that success or failure of this transaction would be determined by whether or not the combined entity would be able to deliver on the cost savings potential. The model presented below confirms that the assessment whether $1.25 billion consideration was a “fair price” is fundamentally shaped by one’s assumptions around achieving cost synergies.
The base case assumptions were informed by third party research and the
interviews outlined above. In addition, we conduct a sensitivity analysis that seeks to captures the impact of different assumptions around cost and revenue synergies as well as cost of capital.
Key Base Case Operating Assumptions
The discussion below highlights the key drivers of our base case valuation analysis:
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 16/28
Revenue Growth: We believe that IBM PC would lose market share as competitors capitalize on the inevitable uncertainty created by transaction to steal customers. In addition, we believe that it IBM PC may lose a portion of their U.S. government agency business, which represents an estimated 6-7% of total sales. We assume a five percent volume drop for non-IBM sales in 2005 and volume growth of four percent stemming mainly from the company’s ability to more deeply penetrate emerging markets and grow the consumer market in the U.S. On the pricing side, we assume the historical trend of pricing pressure will continue and therefore project an annual 2.5% price decline in line with current trends. The net result is marginal revenue growth of 1.4%.
Table C: Revenue growth drivers Actual 2004 NET REVENUE External Sales Volume Price Net Volume-Price Effect Net Revenue Growth Sales to IBM Volume Price Net Volume-Price Effect Net Revenue Growth
100.0% 100.0% 100.0%
95.0% 97.5% 92.6% -7.4%
98.8% 95.1% 93.9% 1.4%
102.8% 92.7% 95.2% 1.4%
106.9% 90.4% 96.6% 1.4%
111.1% 88.1% 97.9% 1.4%
100.0% 100.0% 100.0%
100.0% 97.5% 97.5% -2.5%
104.0% 105.6% 109.9% 12.7%
108.2% 103.0% 111.4% 1.4%
112.5% 100.4% 112.9% 1.4%
117.0% 97.9% 114.5% 1.4%
Gross Profit Margins: We assume margin improvement over five years for IBM PC, ultimating reaching Lenovo’s 13% margin in 2009. Approximately half of the margin improvement is a result of the $150-200 million procurement savings per year. The remainder stems from the operational rationalization of the business, including moving manufacturing to China.
Table D: COGS drivers Actual 2004 COGS As % Net Revenue EXTERNAL Sales Sales to IBM
Operating Expenses: As noted in the “Strategic Rationale” section of the paper, the industry SG&A expense ratio average is 6.8% and Lenovo’s current expense ratio is 4%. We assume that The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 17/28
the IBM PC portion of the business reach the industry average by 2009. We assume no increase or decrease in R&D expenses as a percentage of revenue.
Table E: Opex drivers Actual 2004 EXPENSES SG&A as % of Net Revenue R&D as % of Net Revenue
2009 6.8% 1.3%
Warranty Savings: We assume a warranty savings in 2005 of $324 million and $235 million in 2006, in line with Goldman Sachs and TPG estimates of between in $250-400 million per year. We would expect there to be additional warranty savings past 2006.
However, since most
warranty contracts are for three years or less and IBM only covers warrant contracts entered into prior to the acquisition, we expect these savings to be negligible.
Table F: Warranty savings
Actual 2004 WARRANTY SAVINGS As % External Net Revenue
Projected 2007 0.0%
Effective tax rate: Tax expense charged to Lenovo-IBM PC during the first quarter of 2005 was equivalent to a 29.5% effective tax rate, significantly higher than the 2% that Lenovo has been historically charged in China, where it has received preferential tax treatment. The steep increase in the effective tax rate results from the Company’s operations in higher-tax regimes such as the United States and Japan. According to Viktor Ma at Morgan Stanley, the company expects the tax rate to stay around the 29-30% level for the next year but will look for tax arrangement opportunities to lower the effective rate in the future. 43 For the purposes of our analysis, we assume that IBM PC has a tax rate that is equivalent to the combined business. We believe that the tax rate will decrease, due to the combination of expansion into lower-rate tax regimes and more effective tax planning, and stabilize at a level of around 25%. 43
Viktor Ma, “Great Start,” Morgan Stanley Research, August 12, 2005, p. 5. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 18/28
Working Capital and Capital Expenditures: We assume that working stays a constant -6.6% of sales and that capital expenditures increases from the current 1% of net revenues to 1.5% of net revenues to account for potential capital outlays in addition to maintenance capital expenditures.
Cost of Capital We assume a 15.9% cost of capital. We used the WACC methodology to calculate the cost of capital, since we believe that it is a reasonable assumption to assume a steady debt-to-equity ratio for this business on an ongoing basis. We arrive at the cost of capital by looking at the betas of three comparable companies in the global PC business – Apple Computer, Dell and Hewlett Packard. We then unlevered the equity betas. Since the three comparable companies all have significant cash positions, we examined their historical financials and noted that have had significant cash balances over the past five years. We took the average cash balance and treated it as operational cash and the remainder as excess cash, used to calculate the “real” level of negative net debt (cash) that should be used to unlever the betas. For the details of the calculations, please see Table G below.
Table G: Asset beta calculation based on comparable companies Equity Beta
Comps Apple Computer Dell Hewlett-Packard Average
1.50 1.22 1.77 1.50
Market Cap 62,644 75,713 85,721
TEV 54,383 67,082 77,015
Net debt/ Operating (Cash) Cash (8,261) (8,631) (8,706)
(2,500) (5,000) (6,500)
Excess Cash (5,761) (3,631) (2,206)
D (cash)/V Adj. E/V (0.11) (0.05) (0.03)
1.11 1.05 1.03
Asset Beta 1.66 1.29 1.82 1.59
We then used the average asset beta of the comparable companies to calculate the cost of capital for IBM PC. We assumed a risk-free rate of 4.5%, based on the U.S. 10-year treasury.44 Though we believe that it is not fully representative of future expected equity market risk premium, we used the best available historical estimate, namely 7.2%. We then used the CAPM to calculate the weighted average cost of capital, assuming an ongoing sustainable debt level of zero.
Financial Times The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 19/28
Table H: Cost of capital assumptions COST OF CAPITAL ASSUMPTIONS Risk free rate Market risk premium Comps asset beta IBM PC D/E IBM PC D/V IBM PC E/V IBM PC equity beta WACC
4.5% 7.2% 1.59 0.0% 0.0% 100.0% 1.59 15.9%
It is worth noting that Even Goldman Sachs admitted that finding the right cost of capital for this complex multi-national, multi-currency transactions was “a big challenge.”45 During our conversations, they mentioned that they thought that “13% was a reasonable number to use for WACC,” without giving any real justification for the figure.46 They did mention, however, that they believed that using a market-risk premium of 5.0% instead of 7.2% was reasonable.47 So, applying the Goldman Sachs best-estimate of the market-risk premium yields a WACC of 12.7%, which is very close to the quoted 13%. Moreover, instead of trying to incorporate the “risks” of the transaction in the WACC, we believe that the best approach is to assess these risks through a sensitivity analysis rather than “baking” these risks into a single cost of capital figure.
Our sensitivity analysis helps us
understand the risks much better than would a more “sophisticated” – and, frankly, in our opinion, convoluted – calculation of WACC using country specific risk premiums and any idiosyncratic risks associated with the deal.
Discounted Cash Flow Valuation Based on the above assumptions, we calculated the enterprise value of IBM PC using a discounted cash flow model. To calculate the terminal value, we have assumed a terminal growth rate of 1.5%, in line with the net revenue growth of 1.4%. Please see Table I below for a summary of the DCF.
Max Chen, interview by authors, December 1, 2005. Max Chen, interview by authors, December 1, 2005. 47 Max Chen, interview by authors, December 1, 2005. 46
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 20/28
Table I: Discounted cash flow analysis
EBIAT CALCULATION EBIT less Taxes EBIAT
(91) (167) (258)
266 (78) 187
362 (98) 264
329 (85) 243
483 (121) 362
560 (140) 420
CASH FLOW CALCULATION EBIAT plus Depreciation/Amortization less change in NWC less Capex plus other non-cash items FREE CASH FLOW
(258) 100 (103) (261)
187 100 49 (95) 241
264 120 (11) (145) 228
243 130 (9) (147) 217
362 135 (9) (150) 338
420 145 (9) (152) 404
Discount factor PV of Free Cash Flows Terminal value
Sum of PV of Free Cash Flow PV of Terminal Value Total Enterprise Value
0.48 193.1 1,357.3
896.8 648.0 1,544.8
Valuation Discussion Our base case assumptions yield a value for IBM PC of US$1.54 billion, 23% higher than the price actually at the time of the transaction. However, we recognize that the valuation is very sensitive to certain key assumptions. We have analyzed the valuation sensitivity to the cost of capital assumptions, the terminal growth rate, the COGS and the SG&A as a percentage of net revenues. Please see the Table J below for the results of the sensitivity analysis.
It is worth
noting that the analysis confirms the view that the Lenovo-IBM PC transaction is a “cost play.” For example, the enterprise value would increase by only $111 million dollars with an increase in the terminal growth rate by 2% (an increase from 1% to 3% at a 15.9% cost of capital), whereas the enterprise value is increased by almost five times that much with either a 2% improvement in COGS or SG&A (again, at 15.9% cost of capital).
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 21/28
Finally, we believe that next logical step in this analysis would be to perform the same analysis for the combined Lenovo-IBM PC business to fully understand the value proposition to the private equity sponsors, given that ultimately they made investments in the combined business.
Table J: Sensitivity analysis Enterprise Value - Terminal Growth Rate & Cost of Capital
Cost of Capital
1,544.80 11.0% 12.0% 13.0% 14.0% 15.0% 15.9% 17.0% 18.0% 19.0% 20.0%
0.00% 2,318 2,081 1,885 1,723 1,585 1,475 1,368 1,280 1,204 1,137
0.50% 2,387 2,134 1,927 1,756 1,612 1,497 1,385 1,295 1,216 1,147
Terminal Growth Rate 1.00% 1.50% 2.00% 2,462 2,545 2,638 2,191 2,254 2,324 1,972 2,020 2,074 1,791 1,829 1,871 1,640 1,670 1,703 1,520 1,571 1,545 1,404 1,424 1,445 1,310 1,326 1,344 1,229 1,242 1,256 1,157 1,169 1,180
2.50% 2,741 2,401 2,132 1,916 1,739 1,600 1,468 1,362 1,271 1,193
3.00% 2,857 2,486 2,196 1,965 1,777 1,631 1,492 1,382 1,287 1,206
Enterprise Value - COGS 2006-onward & Cost of Capital
Cost of Capital
1,120.62 11.0% 12.0% 13.0% 14.0% 15.0% 15.9% 17.0% 18.0% 19.0% 20.0%
91.0% 781 707 648 599 559 527 496 471 449 430
90.0% 1,269 1,140 1,036 951 880 824 769 725 687 654
COGS 2006-onward 89.0% 88.0% 1,757 2,246 1,573 2,006 1,425 1,813 1,303 1,654 1,201 1,522 1,121 1,417 1,043 1,316 980 1,234 925 1,163 877 1,100
87.0% 2,734 2,439 2,201 2,006 1,843 1,714 1,589 1,488 1,401 1,324
86.0% 3,223 2,872 2,590 2,358 2,164 2,011 1,863 1,743 1,639 1,547
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 22/28
85.0% 3,711 3,305 2,978 2,709 2,486 2,308 2,136 1,997 1,877 1,771
Enterprise Value - SG&A 2006-onward & Cost of Capital
Cost of Capital
1,068.38 11.0% 12.0% 13.0% 14.0% 15.0% 15.9% 17.0% 18.0% 19.0% 20.0%
11.0% 686 624 574 533 499 471 445 424 406 389
10.0% 1,176 1,059 964 886 821 770 720 680 645 614
SG&A 2006-onward 9.0% 8.0% 7.0% 1,667 2,157 2,647 1,494 1,928 2,363 1,354 1,744 2,134 1,240 1,593 1,946 1,144 1,467 1,790 1,068 1,367 1,665 995 1,270 1,545 936 1,192 1,448 885 1,124 1,363 839 1,064 1,289
6.0% 3,137 2,798 2,524 2,300 2,112 1,964 1,820 1,704 1,603 1,514
5.0% 3,628 3,233 2,914 2,653 2,435 2,262 2,095 1,960 1,842 1,739
6.0% 946 1,243 1,540 1,836 2,133 2,430 2,727
5.0% 1,244 1,541 1,838 2,135 2,432 2,728 3,025
Enterprise Value - SG&A 2006-onward & COGS 2006-onward
644.21 91.0% 90.0% 89.0% 88.0% 87.0% 86.0% 85.0%
11.0% (546) (249) 47 344 641 938 1,234
10.0% (248) 49 346 643 939 1,236 1,533
SG&A 2006-onward 9.0% 8.0% 7.0% 51 349 648 347 646 944 644 943 1,241 941 1,239 1,538 1,238 1,536 1,835 1,535 1,833 2,131 1,831 2,130 2,428
Multiple Analysis On the surface, Lenovo’s acquisition of IBM PC seems prohibitively expensive at a multiple of 30.1x 2005E EBITDA. However, taking into account the expected cost savings from COGS and SG&A the multiple is actually very reasonable. To calculate the 2005E pro forma EBITDA at the time of the transaction, we added 40% of the expected COGS and SG&A costs saving, US$103 million and US$133 million, respectively. However, we ignored the “one-off” warranty savings that increases 2005E and 2006E EBITDA quite significantly. This adjusted multiple analysis results in a EV / EBITDA multiple of a mere 4.5x. Please see Table K below for the details of the calculation.
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 23/28
Table K: Multiple analysis
MULTIPLE ANALYSIS Enterprise Value (excl. one-off warranty savings) Actual 2005E EBITDA plus 40% est. total COGS savings plus 40% est. SG&A savings Pro forma 2005E EBITDA EV / Actual 2005E EBITDA EV / Pro forma 2005E EBITDA
US$ million 1,250 41 103 (=40%*2.7%*2005E Net Revenue) 133 (=40%*3.5%*2005E Net Revenue) 278 30.1x 4.5x
Of course, this analysis assumes that at least 40% of the cost savings will materialize and that the buyers pay for them upfront. Nonetheless, this analysis is important to fully understand the thinking of the private equity players at the time of the transaction. According to Winston Wu of TPG: “At face value, the EBITDA multiple seemed excessive. However, after incorporating the run-rate synergies and cost savings at a discount, the multiple looked very attractive, in the midsingle digits.”48 Indeed, this multiple was a significant discount to the publicly traded comparable companies at the time of the transaction. Please see appendix for the common stock comparison done at the time of the transaction.49
Conclusion Though it is too early in the execution process to make a definitive judgment about the ultimate outcome of the transaction, Lenovo’s acquisition of IBM’s PC division clearly is on the path to success. As with any ground-breaking effort, the undertaking is rife with significant risks. As detailed in this paper, Lenovo increased odds of success by carefully negotiating a deal to specifically address each of the key risks.
In addition, based on reasonable cost saving
assumptions, they were able to negotiate a very attractive purchase price according to our analysis. Western private equity firms played a crucial role in this process by helping to bridge the significant cultural divide between Lenovo and IBM and by providing crucial financial and 48 49
Winston Wu Source: Goldman Sachs Deal team The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 24/28
As a result of these collective efforts, Lenovo’s acquisition of IBM’s PC
division may come to be viewed as a watershed that not only forever changed Western views about China’s economic ambitions and but also opened an era of significant cross border partnerships that will fuel the continued economic integration of China and the West.
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 25/28
APPENDIX A Private Equity Firms Texas Pacific Group Texas Pacific Group (TPG) is a leading global private equity investment firm. It currently manages over US$13 bn of committed equity capital. Its portfolio of companies generates over US$35 bn in revenues and has over 500,000 employees. TPG is a leading global private equity investor in technology, with investments including MEMC Electronic Materials, ON Semiconductor, Seagate Technology, Business Objects, Conexant Semiconductor, Eutelsat, Isola, Network General, Paradyne Networks and Smart Modular. Other TPG investments have included Burger King, Continental Airlines, Del Monte Foods, Ducati Motorcycles and J. Crew. TPG is based in Fort Worth, Texas, San Francisco and London. General Atlantic Group General Atlantic Group is a leading global private equity firm focused on investing in companies providing information technology or using information technology to drive growth. Investment entities affiliated with General Atlantic LLC make investments on an arm’s length basis in portfolio companies. General Atlantic’s current investments in China include Vimicro and Digital China. The firm was founded in 1980 and has about US$8 bn in capital under management. General Atlantic has invested in over 140 companies and has current holdings in over 50 companies, of which almost half are based outside of the US. General Atlantic Group has offices in Greenwich, New York, Palo Alto, Washington, DC, London, Düsseldorf, Singapore, Tokyo, Mumbai, Hong Kong and São Paulo. Newbridge Capital Group Newbridge Capital Group is one of Asia’s leading private equity investment firms with US$1.7 bn of capital under management. Founded in 1994 by Texas Pacific Group and Blum Capital Partners, Newbridge Capital Group was one of the first private equity firms dedicated to Asian investments. The firm has offices in Hong Kong, San Francisco, Shanghai, Tokyo, Seoul, Mumbai and Melbourne. Newbridge Capital Group has made significant investments in such companies as Hanaro Telecom, Japan Telecom, Korea First Bank, Matrix Laboratories and Shenzhen Development Bank. Source: CSFB Research50
Jeannie Cheung, et al., Lenovo Group: Powering Up, April 12, 2005. The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 26/28
APPENDIX B Historical and Projected Financials INCOME STATEMENT YE December 31, Actual 2001 NET REVENUE External Sales Sales to IBM Total Net Revenue %growth COST OF GOODS SOLD EXTERNAL Sales %revenue Sales to IBM %revenue Total Cost of Goods Sold %revenue GROSS PROFIT EXTERNAL Sales %margin Sales to IBM %margin Total Gross Profit %margin EXPENSES SG&A %sales R&D %sales IP Income %sales Other (income)/expense Total Expenses
9,745 333 10,078
8,962 275 9,237 -8.3%
9,288 278 9,566 3.6%
10,000 278 10,278 7.4%
9,263 271 9,534 -7.2%
9,392 305 9,698 1.7%
9,524 310 9,833 1.4%
9,657 314 9,971 1.4%
9,792 318 10,111 1.4%
8,815 90.5% 333 100.0% 9,148 90.8%
8,066 90.0% 275 100.0% 8,341 90.3%
8,327 89.7% 278 100.0% 8,605 90.0%
8,965 89.7% 278 100.0% 9,243 89.9%
8,289.94 89.5% 257.50 95.0% 8,547 89.7%
8,359.04 89.0% 274.84 90.0% 8,634 89.0%
8,380.83 88.0% 272.50 88.0% 8,653 88.0%
8,449.87 87.5% 274.74 87.5% 8,725 87.5%
8,519.21 87.0% 277.00 87.0% 8,796 87.0%
930 9.5% 0.0% 930 9.2%
896 10.0% 0.0% 896 9.7%
961 10.3% 0.0% 961 10.0%
1,035 10.3% 0.0% 1,035 10.1%
973 10.5% 14 5.0% 986 10.3%
1,033 11.0% 31 10.0% 1,064 11.0%
1,143 12.0% 37 12.0% 1,180 12.0%
1,207 12.5% 39 12.5% 1,246 12.5%
1,273 13.0% 41 13.0% 1,314 13.0%
1,201 11.9% 179 1.8% (134) -1.3% (23) 1,223
1,038 11.2% 138 1.5% (118) -1.3% (94) 964
1,013 10.6% 139 1.5% (75) -0.8% 1 1,078
1,059 10.3% 135 1.3% (68) -0.7% (0) 1,126
982 10.3% 125 1.3% (63) -0.7% 1,045
873 9.0% 128 1.3% (64) -0.7% 937
787 8.0% 129 1.3% (65) -0.7% 851
698 7.0% 131 1.3% (65) -0.7% 764
688 6.8% 133 1.3% (66) -0.7% 754
WARRANTY SAVINGS %external net revenue
EBIT (Incl. warranty savings)
EBITDA (incl. warranty savings) EBITDA (excl. warranty savings)
Source: Company filings, analyst research and authors’ assumptions
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 27/28
APPENDIX C Common Stock Comparison done at the time of the transaction
Source: Goldman Sachs deal team
The Emergence of a Chinese Global PC Giant: Lenovo’s Acquisition of IBM’s PC Division By John Ackerly & Måns Larsson 28/28