Lenovo: PC King With Margin Malaise 联想利润率低迷

Everyone else is commenting on the latest quarterly results from global PC leader Lenovo (HKEx: 992), so of course I need to give my own opinion on this company that could soon find itself facing a number of challenges following its recent taking of the global PC crown from Hewlett-Packard (NYSE: HPQ). I should start with a look at investor reaction to the latest results, which seems to be a yawn of indifference and perhaps some impatience with the company. Lenovo shares lost 2.7 percent after the result came out on Thursday, even though the company’s profit was ahead of expectation. Shares bounced back in early Friday trade and were up more than 4 percent, but the conflicting movement again reflected the growing fatigue investors are feeling toward this company and all of its big talk.

Lenovo Chairman Yang Yuanqing has boasted nearly nonstop in the last since month his company finally overtook HP to become the world’s PC leader in the third quarter of this year. Lenovo used the earnings announcement to talk about its recent big gains in smartphones and its broader inroads in markets like Japan and Germany where it has made recent acquisitions. (company announcement)

The company pointed out that its smartphone business has made rapid advances in China, going from a relative bit player to one of the nation’s top 5 names with 13 percent market share in the most recent quarter. The company is less vocal about the fact that its smartphone business is still losing money, unlike global rivals like Apple (Nasdaq: AAPL), Samsung (Seoul: 005930) and even recently faltering HTC (Taipei: 2498), which all earn profits from their businesses. But Yang did say he expects the company’s smartphone business to be profitable soon, which is certainly an encouraging sign. (English article)

The situation with smartphones reflects a broader mentality at Lenovo, which has become a company obsessed with gaining market share, often at the expense of profits. Such an obsession led to the rapid rise and then equally fast decline of Taiwan’s Acer (Taipei: 2353), which soared to prominence on rapid market share gains only to rapidly fade when it failed to find a sustainable business model.

This lower profile story is most apparent in Lenovo’s profit margins, which are the lowest among the world’s top 3 players. Lenovo’s operating profit margin clocked in at 4.5 percent for its latest reporting quarter, and in a worrisome trend the number was down 0.5 percentage points from the previous year. By comparison, HP’s operating margin stood at about 7 percent for its fiscal second quarter, and Dell’s (Nasdaq: DELL) stood at 6.2 percent.

Even Lenovo’s 4.5 percent operating margin was a bit misleading, since it was inflated by a 6.2 percent margin for its China operations that account for about half of its sales. By comparison, margins in most of its other global markets ranged from a razor thin 0.4 percent for Asia and Latin America, to a somewhat higher 3.7 percent for North America.

One of the few refreshing remarks I read from Yang had him finally admitting that low margins were indeed a problem, and that raising those margins would be an important task for the future. Unfortunately for Lenovo, competition in the global PC and smartphone space isn’t going to ease up anytime soon, meaning the company may have to sacrifice some of its market share if it really wants to improve margins. I don’t see Yang doing that for now, as he will hardly want to give up his prized global PC crown so soon after winning it. Accordingly, look for Lenovo’s margins and profit growth to continue struggling in the quarters ahead, especially as integration issues start to appear for its recent acquisitions in Germany, Japan and Brazil.

Bottom line: Lenovo’s weak margins reflect a company that has sacrificed profits for market share, and the situation is unlikely to improve in the next year.

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This article was first published in the online edition of the South China Morning Post at www.scmp.com.

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