The China trade

The state lands the headquarters of a company from a country many Tar Heel manufacturers love to hate.
By Irwin Speizer

It all began in Beijing 22 years ago with 11 computer scientists working in a two-room house no bigger than a studio apartment. Now, Lenovo Group Ltd.’s new headquarters will be a suburban campus in Morrisville, a setting as foreign as it is distant — 7,130 miles — from that bunkerlike building. Buying IBM Corp.’s personal-computing business was the first acquisition of a major U.S. operation by a Chinese company, and with it came about 1,800 jobs at IBM’s Research Triangle Park campus, which is as much a high-tech icon in North Carolina as Lenovo’s birthplace is in China.

These were jobs the state’s political establishment was determined to keep, even if it meant cozying up to a country many Tar Heel manufacturers have tried to brand as a trade renegade. Never mind that Lenovo is partially owned by the Chinese government. Or that its takeover of IBM’s PC business raises some of the national-security issues that recently scuttled a United Arab Emirates-owned company’s bid to operate U.S. ports. Or even that Lenovo began cutting jobs after winning state and local incentives worth $14 million.

It has agreed to increase its North Carolina employment by up to 400 within 11 years, and for state officials the allure of new jobs — particularly high-tech ones — trumps other concerns. “If the question is, do you make an effort to secure 300 or 400 new jobs for a promising new industry that we expect to help sustain our economy in the future, there is not much of a question there,” says Don Hobart, general counsel for the N.C. Department of Commerce. “Everyone recognizes the role that China’s emergence in the world economy plays. It is an economic reality.” As for security and trade issues, they’re best left to the feds. Morrisville Mayor Jan Faulkner notes, “It was more important for us to look at keeping jobs here locally, not to worry as much about the specific China influence.”

Globalization has been hard on the state’s traditional industries — its textile mills and apparel plants, for example, have shed 170,000 jobs since 1997 — and many manufacturers blame China. Textile and furniture groups lobby Washington for protection against the advantage afforded not just by China’s cheap labor and lax workplace rules but by its currency, which the government keeps weak to make its exports even less expensive.

By buying cheaper foreign goods, U.S. consumers have helped build a huge trade imbalance. China, which has a $200 billion surplus with this country, has spent much of it on U.S. Treasury securities. Now Chinese companies are eyeing American assets, and the state Commerce Department, which has been sending trade missions to the Asian nation, is determined to snare some of that investment. In this case — and almost coincidentally — it snagged a global headquarters.

When Lenovo started talking to Armonk, N.Y.-based IBM about buying its PC division, Commerce officials fretted about the potential loss of Tar Heel jobs but began plotting how the state might benefit from a merger. IBM is the world’s largest tech company, with $96 billion of revenue last year, more than 300,000 employees in 75 countries and clients in 174. In 1965, it had been the first corporation to make a major investment in RTP, an event considered the catalyst in creating what has become one of the world’s premier technology centers. Its RTP operation — which at the time Lenovo came along had about 13,000 employees, including the PC division — is the company’s largest site.

Five of China’s top 15 companies are IBM clients. One is Lenovo, founded in 1984 with a $25,000 grant from the Chinese Academy of Sciences. Originally Legend Computers Ltd., it imported and sold PCs, including IBM machines, before manufacturing motherboards, the backbone of personal computers, then its own brand of computers. By 1997, it was the leading computer supplier in China. As Legend expanded into the desktop and laptop market, IBM was slowly retreating, focusing on technical services and consulting. A section in its 1998 annual report titled “The PC Era is Over” sparked speculation that it would dump that line of business. Though IBM continued making desktops and laptops — most of the manufacturing was overseas, much of it in China — the rise of Dell and sales success of Hewlett-Packard machines made it a distant third in worldwide sales, with market share and profits in its PC division slipping.

Lenovo announced it was cuting 300-350 RTP jobs – and moving its headquarters to the Triangle.

By the end of 2003, IBM and Legend — soon to change its name to Lenovo — were talking. Negotiations dragged on as the Chinese company tried to devise terms by which it could absorb IBM’s PC business, which had $9 billion of sales in 2003 — three times its total revenue. In October 2004, rumors that they were close to a deal circulated. On Dec. 7, they announced they had one, valued at $1.75 billion: Lenovo would pay $1.25 billion in cash and assumed debt, plus IBM would get a stake in Lenovo. While analysts debated whether it was a good price, North Carolina officials scurried to determine what this meant for IBM’s Tar Heel work force. In the announcement, Lenovo said it would keep the PC operation in RTP and move its headquarters from Beijing to Purchase, N.Y., near Armonk.

Then things hit a snag. The Committee on Foreign Investment in the United States, a federal interagency panel, decided in late January 2005 to review the deal. The concern: The PC operation might give China a U.S. base for spying or industrial espionage. IBM has government contracts, and its North Carolina campus is a crossroads of sensitive tech information. But after two months of study, the committee allowed the acquisition with a few stipulations. What they were has never been made public, but news reports said Lenovo would have to move off IBM’s campus at RTP.

That the deal sailed through the committee is no surprise. Created in 1988, the panel is supposed to draw on the expertise of its members, including representatives of the Defense and Justice departments, to vet proposed deals. “These are not agencies known for being light on issues like homeland security,” notes Jeff Carlisle, Lenovo vice president of government relations. Transactions that raise security issues can be forwarded to the president for further review and possible action. But the Chicago Tribune reported last year that only 12 of 1,500 deals the committee has examined had been forwarded. Only one had been rejected — a Chinese company buying a Seattle manufacturer of aerospace parts.

Courtesy of Lenovo

What has derailed several recent takeovers was not the committee but other opposition, primarily in Congress. When Chinese National Offshore Oil offered $18.5 billion last summer to buy El Segundo, Calif.-based Unocal, lawmakers squawked, citing national-security concerns. The company backed off, allowing San Ramon, Calif.-based Chevron to buy Unocal for $17 billion. That’s similar to what happened this year when a United Arab Emirates-owned entity bought the British company that held operations rights to major U.S. ports. The Lenovo-IBM deal has generated no such uproar — at least not yet.

Donald A. Manzullo, chairman of the congressionally appointed U.S.-China Economic and Security Review Commission, has suggested taking a closer look and questions whether the Committee on Foreign Investment is tough enough on foreign-owned companies. Carlisle, who says Lenovo has been working with the commission, maintains that the U.S. has nothing to fear from its ownership of the PC business. “Lenovo is clearly doing everything it can to play by the rules.”

Jeffrey Barlow, a history professor and Asian authority at Pacific University in Forest Grove, Ore., says the deal merited closer scrutiny. Lenovo, after all, still is partially owned by the Chinese government. (After the merger, the Chinese Academy of Sciences owns 27.3 %; IBM, 13.2%.) The paucity of congressional interest, he suspects, is probably due to IBM’s lobbying clout in Washington and politicians’ inability to grasp the implications of a complex tech deal. “How in the world are they going to possibly keep proprietary IBM information from feeding into Lenovo?” he adds. “To me, it’s one of the critical questions.”

Lenovo’s answer, in part, was the decision to move its new employees to another location. The company decided it needed its own campus. That meant the state could lose more than 1,800 jobs if Lenovo picked a site outside North Carolina. Commerce officials went on high alert. In March 2005, Assistant Secretary Tony Copeland and industrial developer Steve Brantley went to Beijing to assure Lenovo officials that North Carolina would do everything it could to keep the company. Lenovo already was shopping for possible sites. On the way out, the Commerce duo ran into a delegation from Westchester County, N.Y. — Purchase — wooing the company.

"It wouldn't be realistic wringing your hands about the cost of globalization and not try to reap one of the benefits."

By last summer, Lenovo’s quest for a new site was in full song. The Commerce Department gave the project a code name — Grace — but, unlike many site searches, there was little doubt who was looking. Any pretense at secrecy was shattered in August when a Durham city official accidentally released a confidential e-mail that included details of the project. At the top of the list: Lenovo wanted $14 million in incentives to stay in North Carolina. About the same time, Commerce was making yet another trip to Asia. Copeland and Peter Cunningham, director of international trade, traveled to Hong Kong to brief Lenovo executives on incentives available in North Carolina.

There was little the state could offer to save jobs, but Lenovo could get millions of dollars for creating some. And local governments were willing to pay to play. Negotiations involving the company, state officials and those from Wake and Durham counties continued. New York was still in the mix, as was the Atlanta region. In October, Commerce Secretary Jim Fain flew to Beijing for some face time with Lenovo officials and toured the company’s computer plant. “We spent time during August and up to October doing everything we could to recruit the project to the area,” Hobart says.

In Raleigh, as the incentives package came together, questions about Lenovo’s Chinese roots came up before the N.C. Economic Investment Committee, an 11-member panel chaired by Fain that doles out industrial-investment grants. The committee quickly decided that the state would be best served by encouraging Lenovo to stay, both for the jobs and to send a message to China that North Carolina was open for business. The big question was how to use the grants to encourage the company to make a long-term commitment. Lenovo could lease space or build it. A lease would let Lenovo relocate if it got a better deal later. Investing in a new building would likely ensure a long stay.

What the committee came up with was a proposal that included a Job Development Investment Grant with two options. JDIGs are the most generous incentives the state has, refunding to a company some of the state income tax withheld on new employees. If Lenovo leased space, Lenovo could get up to 65%. It could get back 73% with a new building. Over the 11 years of the grant, the difference could be worth several million dollars. The carrot worked. Lenovo decided it would build if it stayed in North Carolina.

Morrisville officials figured they had the inside track. The town and Wake County were prepared to offer incentives, and a site in a private industrial park was ready for construction. “We heard that one of the big issues they were having was that they needed to be up and running in early 2007,” Mayor Faulkner says. “They were in a very big hurry, and we had a place for them to build.” That the big hurry was motivated by security concerns mattered little. “We discussed it a little bit, but it didn’t become a major issue. As long as Lenovo was jumping through the hoops of the federal government, I was not worried about the security end of it.”

On Oct. 27, Gov. Mike Easley declared victory, announcing that Morrisville had won the bidding. Lenovo would move 1,820 workers onto a new, $84 million campus in early 2007 and promised to create up to 400 jobs over five years. If it maintained its original number and met annual job-creation targets, it could get $8.4 million in JDIG money. It also got a $750,000 One North Carolina grant, $1 million of worker training and $2 million of tax credits for research and development. Morrisville and Wake County each kicked in $1 million of incentives, bringing the total to the $14 million Lenovo wanted.

Photo courtesy of Lenovo

The company broke ground in February, with plans to move into the project’s first phase as early as next spring. Then, on March 16, Lenovo announced a global restructuring that would cut 1,000 of its nearly 20,000 jobs, including 300 to 350 in North Carolina. That seemed to undermine the promised increase in employment.

But Lenovo explained that the restructuring will bring some jobs — it is moving its headquarters to Morrisville, adding up to 70 positions, plus relocate a call center from Atlanta and a logistics team from Boulder, Colo. The net effect remained unclear. “It was not something we were anticipating,” Hobart says. “And it may be that the company was not anticipating it at the time we were negotiating. Our understanding, based on conversations with the company, is that the company expects that they would still be in a position to meet the performance criteria for the grants.”

To qualify, Lenovo must add 72 more jobs by March 2007 than it had at the time the grant was announced. By March 2008, it must add 144 more. The number increases until the total reaches 400. If Lenovo fails to meet the targets, the grant is reduced each year in proportion to the number of jobs created. If North Carolina employment drops below 1,820, it gets nothing that year. If it has a net job loss two years in a row, it loses the grant.

Lenovo wants to maximize what it gets, Carlisle says, but it won’t sacrifice what its business needs to do that. And right now it needs downsizing and restructuring. “It would be great to get the incentives. Growing our presence [in North Carolina] is still a goal of the company, and we would certainly hope to meet the benchmarks.”

At Commerce, officials are watching to see what Lenovo does. So far, there are no regrets about the courtship of a Chinese company in a state hit hard by competition from other Chinese industries. “There is no question that North Carolina’s low-wage manufacturing industries — many of them — have either closed or shifted production as a result of competition from China,” Hobart says. “But it wouldn’t be realistic wringing your hands about the cost of globalization and not try to reap one of the benefits. These are jobs that are absolutely worth fighting to keep in North Carolina.” The trick now is to see if the grants do that.