Lenovo is becoming the No. 1 global PC vendor in 2012 while gaining traction in mobile devices and servers

by Beau Skonieczny, Analyst

Lenovo continued to make progress toward overtaking HP as the top worldwide PC vendor in 2Q12, led by share gains in multiple PC markets such as Japan, India and China. Total PC unit sales growth continued to outpace the industry, growing more than 24% year-to-year, supporting 35.3% growth over the same period in corporate revenue to $8 billion. Strong sales growth outpaced Lenovo’s increased operating expenses, contributing to a 20 basis point operating margin increase year-to-year to 2.3%. Margin expansion was limited by strong consumer and SMB sales, leading to a less profitable PC product mix as evidenced by a 50 basis points decrease in gross margin year-to-year.

Lenovo will focus on driving share expansion and gaining traction in new markets such as mature market consumer, SMB and emerging markets where Lenovo holds less than 10% market share. As a result, Lenovo will establish greater economies of scale, helping the company invest in product development and sales to drive faster growth; consequently, operating margin will hover around 2% throughout 2012.

Lenovo continues to sacrifice profit to drive rapid growth momentum in mobile devices

Smartphones, which saw units grow 44-times that of the year-ago quarter to nearly 5 million units in 2Q12, remained the leading contributor to Lenovo’s mobile device growth. As a result, Lenovo reached the No. 2 market share position in China smartphone sales.

Lenovo has sustained triple- and quadruple-digit smartphone unit growth over the last five quarters despite smartphone availability currently limited to the China market. With the rest of the world open to expand its smartphone business, TBR believes Lenovo is in a strong position to maintain its growth momentum, which continues to be fueled by aggressive smartphone prices to drive share gains. To support the growth and increased scale, Lenovo will continue to make capital investments to increase its manufacturing capacity, while also investing in R&D and sales to develop and drive awareness around new mobile device products. Consequently, Lenovo’s mobile device margins continue to suffer, evidenced by a $24 million net loss in operating profit in China associated with Lenovo’s mobile device and smart TV products.

We believe Lenovo has developed a successful model in China for its mobile devices, but has struggled to establish any significant traction worldwide. Lenovo is testing its global smartphone expansion strategy in the Philippines, where Lenovo will target local customers with entry-priced smartphones and some higher-end devices to appeal to a broader customer base to gain share with the same momentum as in China.

Lenovo partnered with EMC to drive global server expansion

In a move to enhance its growing position in the highly competitive server market, Lenovo announced a wide-ranging partnership with EMC. This partnership includes a three-pronged approach designed to leverage joint development for x86 servers that Lenovo will bring to market and that EMC will eventually embed into its storage systems. TBR believes this partnership is a shrewd move for both EMC and Lenovo to extend their respective presence in the storage and server markets.

With a historic server presence primarily in China, Lenovo has been working to expand its server business on a global scale, including in the U.S. By teaming with EMC, Lenovo will generate far more market presence and opportunities for its ThinkServer line. EMC’s previous server market experience with Dell will prove valuable for Lenovo as it treads new ground in markets outside of China, but it will also help both companies seize business opportunities in that country as well. Although China’s economy shows signs of slowing, TBR believes plenty of growth opportunities remain in the country for enterprise server and storage products.

Servers will drive margin expansion for Lenovo, but not in the near term

With Lenovo’s corporate goal to reach the top spot in the global PC market, its sights will be set on driving growth in new segments. Given the higher selling prices of server products over commodity PCs, a stronger global server presence will not only drive revenue growth for Lenovo, but will contribute to increased profit dollars that can be reinvested in its rapidly growing smartphone, tablet and smart television product lines. However, it will take time and aggressive pricing for Lenovo to build scale in the global server space and take share from established players such as HP and Dell. Consequently, TBR does not expect any significant margin impact from Lenovo’s server business in the next year.

Please feel free to use this content or call/email Beau Skonieczny (603-929-1166) for additional commentary.

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