Lenovo Looking To Combine HP And Apple Models

By Stephen D. Simpson, CFA | March 14, 2012 AAA

For a variety of reasons, Lenovo (OTCBB:LNVGY) just doesn't often garner that much respect in the market. Whether it's worries about its low margins, dependence on China or vulnerability to competition, Lenovo has long carried a below-peers valuation. As the company looks to leverage its strength in new products, though, this company may yet have more gains to deliver.

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Growing Where Others Cannot
Lenovo's recent quarter highlights some of this company's strengths. Revenue rose 44% in its fiscal third quarter, with EBITDA up almost 46%. Granted, the company's margins are quite low (operating margin below 3%), but the company continues to produce solid cash flow with that margin structure.

How strong was Lenovo? A variety of market watchers estimate that the global PC market grew less than 2% in 2011, due in part to hard drive disruptions tied to flooding in Thailand. Lenovo saw its PC shipments grow 29%.

Taking a Cue from Apple
It has been a long, long time since Apple's (Nasdaq:AAPL) PC business was as relevant from a market share perspective as Lenovo's is today. Nevertheless, Lenovo is looking to copy the Apple model and expand into smartphones and tablets; leveraging a great distribution system and a pretty well regarded brand name. (For related reading, see Steve Jobs And The Apple Story.)

For now, Lenovo is concentrating on emerging markets like China and Indonesia with its A60 phone and IdeaPad tablet. From a relatively small base, Lenovo has grown to the point where it shipped 3 million phones in the third quarter. While Lenovo has a long way to go before it can crack the leadership positions of Nokia (NYSE:NOK) and Apple in the Chinese smartphone market (they collectively hold almost half the market), they're quickly moving in the right direction.

A Share Gainer in PCs
Lenovo was already the number two tablet company in China, but the company has actually been widening the gap in recent years. It's not just China and emerging markets where Lenovo is strong, though. Lenovo is currently the number one vendor of consumer desktop PCs, globally, and it's quickly closing on Hewlett-Packard (NYSE:HPQ) for overall leadership.

Better still, Lenovo is a growing leader in a market where most of its competitors are looking elsewhere for growth. Asus and Acer are certainly credible rivals that care about their PC businesses, but it seems that other major rivals like HP and Dell (Nasdaq:DELL) are looking everywhere else for their future growth (and remember, HP at one point tried to jettison the PC business).

Winning the Pricing Game
Lenovo has had an uncanny knack for becoming a leading contender in almost every market it chooses to target. A virtual unknown at the time it bought IBM's (NYSE:IBM) ThinkPad business, it is now the number one business PC vendor in the world. While its entry into servers hasn't been as successful (yet), the move into smartphones and tablets has seen early success and Lenovo should not be ignored as a future competitor in the U.S. market.

Lenovo has succeeded, at least in part, by offering attractively priced products throughout its markets without compromising significantly on quality or features. While Apple has garnered a reputation recently for being very demanding of its suppliers, Lenovo is likewise always pushing for cost savings through its supply chain and few rivals can earn sustainable free cash flow at Lenovo's price points.

The Bottom Line
Lenovo's shares have been quite strong lately, but the valuation is still not especially demanding. There's a risk that too many sell-side analysts have flipped recently and become enthusiastic Lenovo supporters, but the long-term picture for market share growth is promising. What's more, ongoing success in mobile devices could not only boost revenue, but margins as well.

All in all, while Lenovo does offer above-average risk, the valuation on this stock suggests that it deserves serious consideration from many investors.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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