SMARTPHONES: Lenovo Set for Rebound? Maybe Not So Fast

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Bottom line: Lenovo’s latest results show a company on the cusp of prolonged downturn over the next 2-3 years, as efforts to resuscitate its ailing smartphone business look set to sputter.

Lenovo stands at a crossroads

When is a $714 million loss good news? It appears the answer is when your name is Lenovo (HKEx: 992), the world’s biggest PC maker, which has just thrilled investors by reporting the massive loss in its latest quarterly results. It seems investors were braced for even worse, expecting a loss of just over $800 million due to a previously announced $923 million one-time charge as it cleared out massive inventory of its low-end smartphones that have failed to find a market in China or overseas.

Of course I’m being slightly sarcastic in my assessment, since such a massive loss is never a good thing and Lenovo in this case simply wasn’t losing as money as quickly as many were expecting. But the better-than-expected result still sparked a rally for Lenovo’s shares in Hong Kong, with the stock finishing up nearly 6 percent after an earnings report that was quite uninspired otherwise.

It’s worth noting the rally had slight overtones of a dead-cat bounce, since Lenovo’s stock had lost nearly half of its value over the last 6 months on a steady string of bad news. Most of that centered on its struggling smartphone business that chief Yang Yuanqing has billed as the centerpiece of the company’s future, as growth for its core PC business stalls in sync with the global market.

Yang has certainly been down this road before, most notably when he made his first major acquisition of IBM’s (NYSE: IBM) PC business a decade ago. Lenovo also suffered after that deal due to integration issues, but ultimately emerged as a stronger company. Some might argue the case could be the same now, only this time we just need to substitute the name Motorola smartphones for IBM PCs. But I might argue that this time may be different, and Lenovo could be standing on the cusp of a longer downturn.

First let’s look briefly at Lenovo’s latest quarterly results, which saw the company post its first quarterly loss in 6 years due to the massive charge. (English article; Chinese article) Without that charge it would have been profitable, and I do expect the company to quickly return to profits in the current quarter.  Lenovo’s latest quarterly revenue rose a respectable 16 percent to $12.2 billion. Its mobile division saw revenue double to $2.7 billion, with roughly half of that coming from its recently acquired Motorola division.

Moto on Track for Profits

Yang heartened investors by reiterating his previous forecast that the Motorola division, which Lenovo bought for $2.9 billion last year, would become profitable in the next 1-2 quarters. But much of Motorola’s progress has come on a major slim-down for the former brand that was once a leader in the global smartphone market.

At this point it does seem like the Motorola clean-up is complete, so we’ll have to see how the brand performs going forward after sharp sales declines over the last year. My best guess is that Lenovo will have a difficult time restoring Motorola to its former glory, and may ultimately write off the acquisition completely. We’ve already seen early signs of Lenovo’s own wavering confidence in the turnaround with its launch of a new brand called Zuk similarly aimed at the middle end of the market.

At the end of the day, Lenovo has fallen quite behind in the global smartphone race that’s likely to ultimately overtake its core PC business. That’s forcing the company to play catch-up, and it certainly has the resources to quickly gain share in a fast-changing market where today’s superstar can become tomorrow’s loser. But in this case I have yet to see any signs that Lenovo can become a serious player in smartphones, and really do think the company is standing on the cusp of a prolonged downturn.

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