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Lenovo’s Good Fortune

Aran Darling

Lenovo Group Limited - HKG:0992 / US ADR: LNGVY

Price (as of market open 12/20/11): Common HKD 5.50 / ADR USD 13.80

Macro Picture

Despite a worsening global economy and supply chain risks from floods in Thailand, Lenovo’s winning streak will likely continue through 2012. Dominance in the Chinese market and impressive growth elsewhere are the main drivers behind the company’s positive outlook. Lenovo’s focus is on M&A and developing new products like tablets and smartphones. According to IDC, the company is now the world’s second largest PC vendor by shipped units/quarter and market share - 12M in 2Q11 and 13.5%, respectively.

Strong Recent Results and Valuation

The highlight of the 09/31 results was a net income of US$143.9M, a 32% QoQ increase. That came by way of a total turnover of US$7.6B, up from 5.67B in 2010. GM remains above 12% and OM held above 2%. A buy recommendation is based on a DCF target of $16.63. LVGNY has a dividend yield of 2.2%, and is trading at 17x P/E and 6x ex-cash, which is low on its historical band and a bullish signal.

Performance Breakdown by Region

Lenovo is in an ideal position for domestic growth. In 2Q11, China overtook the US as the largest PC market, with 18.5M units bought that quarter. Lenovo commands nearly 1/3 of the Chinese market, with all other competitors below 10% each. The company’s dominance at home is supported by its origins as a state owned enterprise. It was formerly called Legend, which is now a holding company and 34% shareholder. Lenovo has a vast channel network including rural access and 15,000 stores nation-wide.

Last quarter was also impressive for Lenovo’s global growth. For the first time, it generated more sales in mature markets than in China ($3.3B vs $3.2B). This happened via the acquisitions of NEC in Japan and Medion in Germany. Emerging markets comprise 17% of Lenovo’s sales. With HP’s PC troubles, Dell’s downgraded forecast, and Acer’s losses, Lenovo is set to further increase global market share.

Cashflow from Products and Innovation Considerations

CFO, last quarter, was derived from the sale of notebooks (58%) and desktops (38%). The remainder was comprised of products in the Mobile Internet Digital Home (MIDH) line. The company spent over US$300 million on R&D in FY11, and will spend ~400M this year. The current priority is tablets and smartphones - with vast potential market value. This year has seen Lenovo launch two IdeaPad tablets (the IdeaPad branding is from its 2005 IBM PC acquisition) and the sub-1000 RMB A60 smartphone.

Innovation at the company also benefits from government assistance with Lenovo having the exclusive right to develop and sell products made at the Academy of Science’s Institute of Technology in Beijing.

Sustainable Outlook

This year has seen the retirement of the founder and chairman, Liu Chuanzi. His replacement, Yang Yuanqing, has been with the company for decades and will maintain the current strategy.

Lenovo uses its near-guaranteed success at home to expand globally. With a growing reserve cash position of roughly US$4B, the strategy appears to be working. While there is some risk that Chinese consumption and GDP growth rates will ease, the measures are based on a larger base, which means the market permeation will hold up. LVGN is a solid play on Asian and EM growth through a debt-free state-supported company in an industry with high barriers to entry. Expect more fireworks from the Red Chip tech giant as it continues with its multi-year plan to become the world’s top PC maker.