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Lenovo Will Dominate Supply in the “PC Plus” Era

2012 witnessed the monumental rise of Lenovo (LNVGY.PK) to start challenging the might of long established laptop manufacturers Dell (NASDAQ:$DELL) and Hewlett-Packard (NYSE:$HPQ) to become the second biggest player in this industry while simultaneously becoming a dominant player in China’s smartphone market. Now, Lenovo is moving to conquer its supply chain. The company currently manufactures one-fifth of its notebooks in-house. By the end of 2013, it will be manufacturing half of its notebooks in-house and in the next three to five years, 100% of the production will be done by Lenovo itself.  Global PC sales may be slowing down and the market may be in terminal decline but Lenovo still sees opportunities for growth within that shrinking pie.

Among the top PC makers of the world, Lenovo has been the only one whose US shipment numbers increased in 2012. In the third quarter of 2012, when HP, Acer and Dell reported drops in worldwide shipments of 10+%, Lenovo came forward with an increase of 10.2% in quarterly shipments from 2011.

Both IDC and Gartner agree that the company shipped 13.8 million units in the third quarter and its rise is at HP’s and Dell’s expense.  The company’s success has come not only due to its aggressive price cuts but also because of its innovative products, the new hybrid laptops (e.g. IdeaPad Yoga, ThinkPad twist and IdeaTab Lynx) that are bridging the gap between a traditional laptop and a tablet with touchscreens that are either detachable or can take a full 360 degree turn.  Moreover, the company has been very successful in maintaining brand equity in the ThinkPad, something the company is extremely cognizant of, which allows it to pull in higher margins on those business warrior laptops whose emphasis on being big, black and chunky are the antithesis of the Macbook which still sets the ThinkPad apart from the crowd of nigh-disposable portable computers.

In a recent interview, Lenovo’s Chief Yuanqing Yang said “We don't live in a post-PC world,” despite the apparent slowdown in PC sales, “We are entering the PC plus era" where innovation is the key to survival. However, to continue with its policy of offering high end products at reasonable prices, Lenovo needs a greater control of its supply chain. The company currently has contracts with Taiwanese manufacturers but when it does in-house production, most of its components come from local Chinese firms. By expanding its domestic production base, Lenovo is looking to drive down its manufacturing costs and destroy what’s left of HP’s and Dell’s margins.  While neither of these companies are or should be focused on this commodity-level business, Lenovo is going to ensure that if they are they won’t be for very long.

Lenovo is expecting to ship around 30 million notebooks this year. Its current focus will translate into a loss of business of around 9 million notebooks for Taiwanese manufacturers in 2013. On the other hand, the Taiwanese ODMs (Original Device Manufacturers) believe that it is neither feasible nor possible for Lenovo to achieve this feat of complete in-house notebook manufacturing in three to five years.   But, like everyone else in today’s markets, talking your book in public is the norm. 

Nonetheless, Lenovo is moving forward with its plan. It has a joint venture with Compal Electronics called LCFC (Hofei) Electronics Technology which is due to start production in early 2013 from a facility located in Northern China. The business is also setting up production lines in the U.S and Brazil. The American plant is located in Whitsett, North Carolina and will be primarily used to cater to the needs of the U.S market. On the other hand, the Brazilian plant is much grander facility with an investment of $30 million; housing both a factory and distribution centre.  Both U.S and Brazilian plants will begin production this year. In the U.S, Lenovo has surpassed Acer to become the fourth biggest PC vendor at 8.3% of the market share whereas HP dominates with more than a quarter of the market. However, Lenovo is the only player in the entire industry that is reporting increasing shipments in America. A feat not even Apple (NASDAQ:$AAPL) has been able to achieve.

Lenovo’s successful moves to attack both up and down the market in multiple market segments highlight a number of things, not the least of which is the inherent weakness of their competition either because of poor corporate governance (HP), a lack of strategic vision (Dell, HP) or shifts in business model (Dell).  Supply chain games are rampant in this industry and getting access to components can be as much about what your competition does to block you as it is about your ability to finance and pay for the orders themselves.

Lenovo is smartly trying to mitigate those risks as much as possible while also driving up gross margins.  There is plenty of room for the competition to fall or make a mistake and this strategy will increase the likelihood of that happening.

 

Lenovo*

Dell

HP

Stock 6m

+32.07%

-11.14%

-17.05%

EPS

0.05**

1.47

-6.41

Yield

1.92%

3.00%

3.40%

P/E

19.52

7.44

N/A

ROA

3.28%

4.81%

5.02%

ROE

22.58%

27.63%

-40.91%

Qtrly Revenue Growth (yoy)

+11.40%

-10.70%

-6.70%

* Lenovo Group Limited (0992.HK) ** HK$0.39 converted to US$0.05

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Peter Pham is a capital market specialist and entrepreneur.  With expertise as a Head of Institutional Sales and Trading he closely watches the market and probes for investment opportunities utilizing a unique blend of quantitative trading experience and macro trend analysis… (read more)

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