Lenovo Q3 – Narrow squeak.

Lenovo can absorb Motorola and just avoid red ink

• Lenovo will be skating on very thin ice when it absorbs Motorola as the handset maker is so unprofitable that it could push Lenovo into the red.
• Lenovo reported good Q3 results as it gained share in PCs but margins remain wafer thin.
• Q3 Revenues / Net income were $10.8bn / $265m compared to forecasts of $10.5bn / $244m.
• Lenovo has done well in PCs gaining share again in all regions taking global share to 18.5%.
• Share in smartphones was stable with 13.5m units shipped.
• Despite the good news, margins remain wafer thin with EBIT of just $334m or 3.1%.
• There is logic in taking on Motorola Mobility (see here) but it is going to put a massive dent in Lenovo’s very fragile profitability.
• Motorola Mobility has been losing around $200m per quarter for the last few years and there is no sign of this changing.
• Hence, when Lenovo takes on Motorola margins will immediately collapse to just 1.2%, all thing being equal.
• Furthermore, I expect that large parts of Motorola’s existing operations will be closed down resulting in a restructuring charge of at least $500m.
• Once the Motorola brand has been migrated to Lenovo’s existing products, then there should be some traction but it is going to take time.
• Together Motorola and Lenovo had 6.4% of the smartphone market in Q4, moving into third position, just ahead of Huawei and LG.
• This is not going to be enough to see decent profitability as Android is increasingly going to require scale to earn a reasonable return and so large swathes of market share will need to be won.
• I estimate that to see a reasonable return on this investment, Lenovo needs to increase market share to at least 10%.
• This will put some leverage into the business and allow margins to improve from the commodity margins earned by most of the Android camp.
• The combination of Lenovo’s manufacturing and Motorola’s brand is a good start but a heavy sprinkling of marketing magic will be required to achieve a level of volume where margins will be acceptable.
• Hence, I think that Lenovo’s margins are going to head south for at least the rest of 2014E and I am not at all confident that it can succeed where so many have failed.
• That being said it has done a good job in PCs although it has been unable to lift profitability despite being the clear market leader.
• Something special is needed if this is not to be a major disappointment and I would not be rushing to buy the shares of Lenovo just yet.