IBM

(IBM) - Get Report

made its rumored exit from the PC business official late Tuesday, announcing the sale of the storied but long-suffering segment to Chinese computer maker

Lenovo Group

for $1.75 billion.

As was widely expected, Armonk, N.Y.-based IBM and Lenovo also said they will enter a strategic alliance and IBM will hold a minority stake, at 18.9%, in the Beijing-based company.

Under the terms of the deal, Lenovo, which is China's top PC company, will pay IBM up to $650 million in cash, funded through internal cash and debt, and up to $600 million in Lenovo common stock, subject to a three-year lock-up period. Lenovo's equity issuance price will be HK$2.675 per share. The company, formerly known as Legend Computer, will also assume about $500 million in liabilities from IBM.

Under the strategic alliance, which was rumored to be in the works to ensure IBM customers don't jump ship, IBM will become the preferred services and customer financing provider to Lenovo, and Lenovo will be the preferred supplier of PCs to IBM. IBM will provide marketing and sales support for Lenovo products through its enterprise sales force, while Lenovo products will be sold by IBM PC specialists that will join Lenovo. IBM financing and global services will be preferred providers to Lenovo for leasing and financing services and warranty and maintenance services.

Lenovo will gain 10,000 current IBM employees, bringing its total workforce to about 19,000, as well as IBM's worldwide distribution and sales network, and the ThinkPad brand of notebooks. The company is projected to quadruple its current annual sales to $12 billion, based on 2003 business results, and give Lenovo 8% global unit market share, according to IDC. In a press release, Lenovo suggested that the deal gives it better service and support for consumers and enterprise clients and market leadership in the China, the world's fastest growing IT market.

The transaction, expected to close in the second quarter of 2005, will result in minimal financial impact to IBM's fourth-quarter results. It requires approval of Lenovo shareholders.

"IBM getting out of the PC business is not a tremendous blow to them, and as a matter of fact will increase their operating margins 150 basis points," Alan Loewenstein, a co-manager of the John Hancock Technology fund, said of the deal. His fund holds shares of H-P and Dell.

The deal could also present an opportunity for rivals

Dell

(DELL) - Get Report

and

Hewlett-Packard

(HPQ) - Get Report

, Loewenstein added. "I could see the marketing campaigns coming out: 'Why buy IBM when you don't know what you're buying,'" he said.

Indeed, in an interview with

CNBC

Tuesday, CEO Michael Dell said his firm has already contacted IBM customers who could be affected by the deal, just on speculation of it happening.

"They're moving in a totally different direction than we are," Dell said of IBM, calling the sale part of a longer-term consolidation trend. "I think what we've done is make computers a lot more affordable."

The IBM deal, meanwhile, casts a shadow over H-P's controversial purchase of PC maker Compaq and puts more pressure on the company to spin off a piece of itself, though not necessarily the PC unit, said Matt Kelmon, manager of the Kelmoore Strategy Eagle Fund, which holds shares of IBM, H-P and Dell. "The PC is just a dying business whereas software is not new but closer to infancy than hardware," said Kelmon. He predicted IBM may use some of the cash from the PC sale to snap up some smaller software vendors.

In fact, H-P CEO Carly Fiorina acknowledged Tuesday that the company's board has rejected breaking up the company three separate times in the past. She defended the company's strategy at its analyst day, saying future growth depends on its portfolio of products, including services, storage, personal computers and printers.

But while Wall Street has

applauded the move by IBM, others have been more critical. Rob Enderle, a principal analyst with the Enderle Group, said IBM's sale to Lenovo in particular is a mistake because the Chinese firm doesn't have experience in corporate or international markets. That will turn off IBM customers across a broad range of product lines beyond just PCs -- especially because IBM has been assuring those customers for years that it wouldn't sell its PC division, Enderle said.

"This could be a case where whatever number IBM gets from the sale will be eclipsed" by what the company loses in other deals, Enderle said. "I think it's going to be problematic for

IBM long term." Other companies such as Fujitsu or Hitachi would have been better buyers, he said.

Unlike Kelmon, Enderle believes IBM's PC sale doesn't mean H-P's Compaq acquisition was the wrong move. Rather, being in the PC business when IBM is leaving could give H-P, in particular, a stronger hand with IBM customers across a broad range of categories because it the most similar to IBM, Enderle said.

Finally, another potential beneficiary of IBM's departure from the PC market could be

Gateway

( GTW). About 50% of IBM's PC sales were to the mid-market, an area where Gateway also operates, noted Enderle.

"Gateway a year ago and Gateway today are two different companies," Loewenstein added of the oft-struggling PC maker. He highlighted the recent success of its eMachines, acquired earlier this year, at retailer

Best Buy

(BBY) - Get Report

. "So far this Christmas season they're actually doing pretty well."

Although IBM popularized the personal computer for business use, it has not done well as a seller of PCs for years. Of the top 10 worldwide PC venders, only Dell has consistently been profitable in the past several years, according to research firm Gartner. In the first nine months of this year, IBM's personal systems group, including PC's, earned a miniscule $70 million in pre-tax income on $9.3 billion in external sales.

Shaken by losses in the PC business -- which totaled just under $1 billion in 1998 alone -- IBM sold all of its U.S. PC manufacturing plants to

Sanmina-SCI

(SANM) - Get Report

in 2002. Meanwhile, the tech behemoth has stepped up its presence in consulting services with the purchase of PricewaterhouseCoopers' consulting unit for $3.5 billion two years ago. And the company continues to lead in the server market, with 31.8% market share in the third quarter, compared to H-P's 27.8% and Dell's 9.8%, according to Gartner.

That's in stark contrast to IBM's paltry 5.6% share of PC shipments in the third quarter, a slight increase from 5.2% market share in the same period a year earlier but still far short of its rivals. Industry leader Dell commanded 16.8% market share in the third quarter, up from 15.2% in the same period a year earlier, and Hewlett-Packard came in second with 15% of the market, flat from the same period a year earlier.

"When you talk about PCs really IBM never comes up anymore," Loewenstein said.

IBM's departure from the PC business comes amid a sales slowdown and predictions of consolidation. Less than two weeks ago, Leslie Fiering, research vice president for Gartner's Client Platforms group, predicted three of the top 10 PC manufacturers will exit the market by 2007 as growth rates slow and profit margins shrink.

PC unit growth will average 5.7% annually from 2006 to 2008 -- half the 11.3% average growth between 2003 and 2005, Gartner forecast. And PC revenue will grow even more slowly, averaging 2% annually from 2006 to 2008, or less than half of the 4.7% average between 2003 and 2005, Gartner forecasts.

Fiering presciently predicted that the PC divisions of H-P and IBM are vulnerable to being spun off if they become too much of a drag on margins. "Exiting the market may be the only logical choice for global vendors bleeding profits and struggling for share," Fiering wrote in an analysis of the PC industry released Nov. 29.

Fiering added that the growing prominence of emerging markets could open opportunities for local vendors, including China's Lenovo, to pursue global markets.