Lenovo And Huawei: Chinese Smartphones Ready To Take On The World

| About: Lenovo Group (LNVGY)

Defined investment criteria are one thing, but most will agree there is no one magic formula for stock picking. It tends to come down to a combination of careful, ongoing research and a having a flexible thought process. When you see macro-economic factors limiting overall stock market returns, finding good quality companies with plenty of growth and dividend potential becomes particularly enjoyable.

The two largest and most successful vendors of smartphone and tablet products at this time are Apple (NASDAQ:AAPL) and Samsung Electronics (OTC:SSNLF). Next to U.S. Pink Sheets, Samsung is also listed on the London market under symbol SMSN. Samsung is currently leading over Apple in global smartphone sales due to Samsung's larger multi-tier product portfolio, but Apple continues to lead as the single-most profitable smartphone maker, taking over 57% of smartphone operating profits in Q1 2013. Within the Android portion of smartphone profits, Samsung is taking the lion's share with $5.1 billion in operating profit equating to 95% of all Android revenues, and 40.8% of smartphone operating profits.

Even though Samsung is running full steam ahead and continues to apply pressure on Apple's very healthy margins, for the short and medium term it still has a ways to go before it equals Apple in terms of sheer brand recognition, as Apple has very skillfully built its brand as the premium offering. This premium brand image is one of reason why the Cupertino-based firm has so long resisted to launching a lower-cost, more cheaply made handset. That mindset may need to change if Apple wants to keep up with the competition in emerging markets in Asia, South America and Africa where consumers often have a bigger budget constraint. Increasing the bang, while lowering the buck, is the general consumer trend nowadays.

So the question then becomes, which vendors could plausibly make a dent in Apple and Samsung's sheer dominance of this space during the next 5-10 years. Many would propose BlackBerry (NASDAQ:BBRY) and/or Nokia (NYSE:NOK), but I would argue that these two companies will have difficulty enough maintaining their current positions given the constant onslaught of new devices. Taking into account their relative capital constraints compared to the big players, perhaps these two firms would be best suited as niche players, focused on the specific needs and requirements of a smaller but very loyal customer base.

In the worldwide smartphone market, vendors shipped 216.2 million units in 1Q13, which marked the first time more than half the total phone shipments in a quarter were smartphones. The market grew 41.6% compared to the 152.7 million units shipped in 1Q12. In addition to smartphones displacing feature phones, the other major trend in the industry is the emergence of Chinese companies among the leading smartphone vendors.

Chinese vendors Huawei Investment & Holding and Lenovo Group (OTCPK:LNVGY) have made significant strides to capture new users with their respective Android smartphones and there is compelling proof that Chinese vendors are eating into their foreign counterparts turf, with strong performances on their home market showing it's possible for Chinese firms to effectively compete with the likes of Apple and Samsung.

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Huawei is perhaps the most enigmatic vendor in the world of telecommunications. The company was founded in 1987 by ex-military officer Ren Zhengfei, has 155.000 employees, and now serves 90% of the world's largest telecoms operators. Huawei is still a private, employee-owned company, with about 65.000 staff members holding shares. Quite unfortunate for us Western investors, as it has slowly build itself into the world's largest telecommunications equipment maker, and has been readying for a major assault on the consumer market for quite some time now.

Huawei made a splash at world's largest consumer electronics show in Las Vegas in January, when it introduced a smartphone with a 6.1-inch display, in an effort to access the successful "phablet" market, currently dominated by Samsung's Note II. Huawei also unveiled another powerful smartphone, with an advanced 5-inch display, a proprietary 1.5-gigabyte quad-core CPU along with Google's (NASDAQ:GOOG) latest Android Jelly Bean operating system.

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Sales from the Chinese market totaled CNY73.579 million for Huawei, an increase of 12.2% Y-o-Y, with consumer business growing over 30%. Continuous expansion in Europe, the Middle East, and Africa resulted in earnings of CNY77.414 million from those regions, an increase of 6.1%. Growth momentum in Japan, Indonesia, Thailand, Australia, and other markets in the Asia Pacific region, increased sales revenue 7.2% year to CNY37.359 million. In the Americas Huawei experienced robust growth in infrastructure networks across Latin America, and growing consumer business in North America, generating CNY31.846 million, an increase of 4.3% Y-o-Y.

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The company recently forecast average annual revenue growth of 10% over the next five years, as it benefits from cloud computing, data analysis and smartphone sales. Although management has stated they will keep an open mind about offering shares to the public in the future, most likely in an effort to boost transparency, the company has no immediate need to raise funds and therefore an IPO will likely be some way off.

Despite already being a formidable smartphone vendor on its home market, outpacing Apple and Huawei in terms of growth, Lenovo Group - tradable through U.S. OTC, Hong Kong en Xetra - is currently best known as the world's second-largest PC vendor, virtually matching Hewlett-Packard (NYSE:HPQ) in global market share in Q1 2013 with 15.3% compared with HP's 15.7%. This position has been achieved in a relatively short timeframe through a combination of fast growth and acquisitions, most recently acquiring Brazil's CCE in January 2013, German company Medion in 2011, and the PC division of International Business Machines (NYSE:IBM) in 2005.

Lenovo also plans to become a truly global player in servers and storage devices within three years. Talks with IBM to buy parts of their server division broke down recently after the two sides couldn't agree on a price, but given a timely May 31 filling with the HK exchange to raise unsecured and unsubordinated debt in U.S. dollars for working capital and possible acquisitions, Lenovo remains first in line to buy IBM's server business, given its desire to enter the x86 server market on top of its current arrangement with EMC Corp (EMC).

After Japanese media recently reported Lenovo and NEC (OTC:NIPNF) were preparing to establish a smartphone joint venture, Lenovo released the following statement to the HK Exchange: 'The board would like to inform the shareholders of the company and potential investors that the company is in preliminary negotiations with a party in connection with a potential joint venture transaction'. NEC's struggling PC business was injected into a joint venture with Lenovo in 2011, in which Lenovo currently owns 51%, achieving a stronger foothold in the difficult Japanese market in the process.

Lenovo is aggressively pushing its mobile devices division towards global expansion after it became the second-largest smartphone vendor in China, closely following market leader Samsung. Lenovo's smartphone market share in China has jumped to over 13% from 4.1% in 2011. Samsung currently hovers around 17.5%.

By the end of this year the company will have entered 10 new markets which include India, Indonesia, Russia, the Philippines, Vietnam and Nigeria. If Nigeria proves to be a success, the company will also look at other African countries. The strategy is simple enough, protect the market share and profits you have, grow globally, and attack new segments like smartphones, tablets and servers.

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During a recent conference management made a couple of interesting statements. The company is planning to boost smartphone shipments 72% in 2013 to 50 million units, and tablet shipments is targeted at 10 million units from 2.2 million last year. Expansion of the mobile devices business may be further bolstered by acquisitions. With more than $3 billion in cash reserves, Lenovo is able to pursue an acquisition of almost any size to expand in new business areas according to their CFO Wong Wai Ming.

CEO Yang Yuanqing mentioned the company is confident its handsets can compete in mature markets like the U.S., where they are planning to start selling smartphones within one year. Lenovo's K900 was first showcased at CES in January and packs the Intel Atom Z2580 dual-core 2 GHZ processor, a 5.5-inch 1080p Full HD display, 2GB RAM, 16GB internal storage, 13 MP camera, and a 2500 mAh battery.

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The underlying results speak for themselves. For the full fiscal year ended March 31, 2013 Lenovo's profit rose 34% to $635 million on a 15% rise in sales to a record $34 billion.

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EPS rose 33% and total 2012 dividend increased 34% Y-o-Y. Lenovo goes ex-dividend twice a year, again in July (Final) and November (Interim) 2013, current dividend yield 3.58%.

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After a 2-year hold the interim conclusion can only be that the management team continuous to executed Lenovo's business plan very effectively, resulting in an impressive annual growth rate and an attractive dividend. Based on ratios and expected growth, holding and adding to the stock during the coming years seems perfectly justified.

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Lenovo's management seems to have a clear vision on where the company is headed in the medium term, and given their knack for achieving the desired results I would find it difficult to underestimate Lenovo's competitive power towards established players in the PC, server, smartphone, and tablet space going forward. The same can be said for Huawei. These are two formidable global companies of which we will be hearing far more in the coming years.

Disclosure: I am long AAPL, GOOG, OTCPK:LNVGY, OTC:SSNLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.