Did International Business Machines Corp. Make the Right Move in China?

By Markets Fool.com

IBM (NYSE: IBM) recentlymade a controversial decision to share designs for its semiconductor chips, servers, and software with select Chinese tech companies. IBM provided partial blueprints of high-end servers to Beijing-based IT company Teamsun, and it licensed designs for its Power8 chip to Suzhou PowerCore for the production of domestic server chips.

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The company signed licensing deals withsoftware firm Youyou, server maker Inspur, and other Chinese companies. IBM is also considering the development of local encryption for its z13 mainframe computers to comply with domestic encryption standards in China.

Those deals could strengthen the IBM business in China, but critics argue Big Blue is exchanging valuable technology for better access to the Chinese market. Is IBM putting short-term revenue growth ahead of long-term political and trade issues?

Torn between two superpowers
In 2013, ex-NSA contractor Edward Snowden leaked damaging information about government cyber-spying practices. Those revelations caused U.S. tech companies to come under intense scrutiny in overseas markets like China.

Orders for U.S. hardware and software declined as suspicions grew that tech companies were serving as "extensions" of the NSA. In a May 2014 interview with state-run media, former top cybersecurity official Shen Changxiang declared that U.S. technological dominance presented "huge security risks" to Chinese national security.

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IBM sales in China start plunging in the third quarter of 2013 with a 22% annual decline, and they eventually bottomed out in the fourth quarter of 2014, when sales slipped 1% annually. Last quarter, IBM did not report China revenues separately, but its adjusted Asia-Pacific revenues fell 2% year-over-year to $4.1 billion, accounting for 21% of the top line. Companywide revenues have fallen for 12 consecutive quarters.

Therefore, the recent tech-sharing partnerships with Chinese companies is a way for IBM to "localize" its business while currying favor with the Chinese government. IBM is not the only tech giant to adopt that strategy. Last October, SAPannounced plans to sell its software on Lenovo and Huawei hardware.

"Absorb and innovate"
In a recent interview, Teamsun VP Huang Hua stated that there was movement in China to replace pricier technology from IBM, Oracle, and EMCwith cheaper domestic hardware.

Huang stated that the Teamsun strategy to "absorb and then innovate" would reduce the tech gap between Chinese and American companies. That strategy is similar to the way Japanese tech companies built their electronics and automotive industries on top of overseas technologies.

However, these partnerships are not unique to China. They are part of an international program called Open Power, which IBM launched in 2013. The alliance -- which has 120 members, including Googleand Samsung-- aims to provide "base" technologies that can be enhanced by local companies like Teamsun, which could lead to stronger overseas partnerships. Fewer than 20 Chinese companies are currently part of the Open Power alliance.

What is so different about China?
The reason China has been singled out from other Open Power countries is that these touch upon several sensitive issues.

Last year, the Chinese governmentprobed major foreign companies, including Microsoft, Qualcomm, and others, over allegations of anticompetitive practices. Since many Chinese companies are subsidized by the government, critics believe those probes were intended to bolster its domestic businesses.

Meanwhile, China has realized it is too dependent on American technologies. That is why it developed its own replacement for Windows, Ubuntu Kylin, and domestic Loongson microprocessors to power supercomputers without Intel. Both are less advanced than their U.S. counterparts, but they are symbolic of a deep-rooted desire to break free from U.S. technology.

Ubuntu Kylin. Source: Company Website

On top of all of that, there is the mutual distrust between the U.S. and Chinese governments, escalating military tensions between China and its Asian neighbors, and unresolved trade issues regarding alleged currency manipulation. Therefore, it is not surprising that IBM's deals with Chinese tech companies are now being thoroughly scrutinized.

What does this mean for IBM investors?
Since IBM usually does not disclose sales from China, it is tough to measure exactly how much of an impact its Open Power partnerships will make. However, those partnerships should foster an improved relationship with the Chinese government and domestic tech companies, which will stabilize business in the region. Whether or not these deals are lopsided ones favoring Chinese companies, however, remains highly debatable.

The article Did International Business Machines Corp. Make the Right Move in China? originally appeared on Fool.com.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Google (A shares), Google (C shares), and Intel. The Motley Fool owns shares of Google (A shares), Google (C shares), International Business Machines, Oracle, and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.