Lenovo Q2 16A – Storm rider

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Lenovo is nicely weathering both the PC storm and its restructuring.

• Lenovo reported Q2 16A results that beat expectations but still recorded losses as the re-organisation of its acquired server and smartphone businesses took their toll.
• Q2 16A revenues / net profit were $12.2bn / LOSS $714m compared to estimates of $11.8bn / LOSS $808m.
• This is a hefty loss for a company with only $3bn on the balance sheet but the good news is that cash flow from operations was a healthy $599m and net cash flow was negative $304m solely due to the repayment of bank borrowings.
• The loss was due to one-time restructuring and provisions of $923m which when stripped away reveal an encouraging picture.
• Market share in PCs grew again to 21.2% and tablets were flat outpacing the tablet market decline of 12.6%.
• It was these market share gains that led to revenue coming in better than expected which combined with steady gross margins allowed losses to be lower than expected.
• Lenovo continues to aim for 30% market share in PCs, $5bn in enterprise revenues and mobile to be profitable in 1-2 quarters.
• I see Lenovo’s development in two stages.
• First: Steady the ship and return to steady profitability and cash flow.
• Second: Execute a strategy to bring margins out of the commodity PC / Android level of 2-4% to something much more respectable.
• This will not be easy as it means that Lenovo must:
  • Either gain substantial market share so that it is meaningfully bigger than its competitors and thereby gain scale advantages,
  • Or differentiate its products such that users are willing to pay a premium to own them compared to similar products from the competition.
• Differentiation in PCs and Android devices is extremely difficult, but not impossible, and will require substantial further investment on the part of Lenovo.
• I think Lenovo understands this dilemma but whether it has the management depth to take a bold step into the ecosystem remains to be seen.
• The good news is that the valuation of the shares does not demand more than commodity margins and I think that returning to the steady state of low margin offers some upside.
• There may be further upside in the long-term if Lenovo can achieve scale of differentiation.
• Consequently, Lenovo is the only PC maker (other than Microsoft) that I would consider being involved with.