Lenovo More Than Holding Its Own, And Built-In Expectations Seem Low

 

Shares of Lenovo (OTCPK:LNVGY) have been nothing special since my last write-up, losing about 15% of their value, underperforming not just the NASDAQ, but peers like Dell (DELL), HP (HPQ), and Hewlett Packard Enterprise (HPE) by wide margins. This underperformance comes despite the company more than holding its own in the PC space and showing improvements in its enterprise and mobile units, as well as launching a distinct, high-margin services unit.

It’s not that unusual for Lenovo to trade below what would seem like fair value, and Lenovo shares have long been climbing that “wall of worry”. Still, in this case, I think it may be excessive. Even allowing for some slowing in the business and management coming up a little short of some of their goals, it’s hard to reconcile the very weak performance that seems to be priced into the shares.

 

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Lenovo More Than Holding Its Own, And Built-In Expectations Seem Low

Lenovo Thumps Sell-Side Expectations With Robust Volumes And Operating Leverage

Long underrated, at least in my view, for its potential to gain share in more lucrative PC categories and drive more operating leverage, Lenovo (OTCPK:LNVGY) has been getting its due lately with the pandemic driving exceptional PC volume growth around the world. While strength in the PC business is certainly carrying the business, I believe there has also been more progress in the server business than may be generally appreciated.

With the shares up over 100% since my last write-up, the valuation and investment thesis have changed pretty significantly. Now risks of a post-pandemic PC slowdown loom larger and a lot more is riding on the company’s growth strategy in servers and data center customers. Taking that all into consideration, these shares have a lot less appeal as a value name and I’m at least considering selling into this strength.

 

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Lenovo Thumps Sell-Side Expectations With Robust Volumes And Operating Leverage

Lenovo Gets No Love For Another Beat, With Investors Focused On Ongoing DCG Investments

Although I flagged overly negative sentiment as a risk for Lenovo (OTCPK:LNVGY) shares in my prior update, it's still frustrating to see, and these shares have continued to lag HP (NYSE:HPQ) and Dell (DELL) since my last update (and over the past year), as investors and analysts remain more fixated on the prospect of ongoing investments to build the data center business than on the successes in the PC business.

Older investors may be familiar with the expression of "don't fight the tape", and that's not bad advice to a point. It seems as though Lenovo will face sentiment headwinds until and unless the DCG turns a profit, but I do believe the company's investments here will pay off eventually. I'm willing to be sort-of patient about this (I will still complain…), and I continue to see Lenovo as meaningfully undervalued as assumptions of low single-digit revenue and FCF growth still drive a double-digit annualized potential return.

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Lenovo Gets No Love For Another Beat, With Investors Focused On Ongoing DCG Investments

Lenovo Facing Familiar Headwinds, And Still Frustrating Bulls

I’ve written more than once that Lenovo (OTCPK:LNVGY) needs a driver beyond its leading PC business to change sentiment on the shares. Unfortunately, both the mobile and enterprise businesses have taken backward steps, and issues like trade tensions with China still loom large. Against that backdrop, Lenovo’s ongoing strong execution in the PC business just doesn’t seem to matter, and the shares have remained weak.

Lenovo continues to look undervalued against what I see as undemanding expectations, including 2% overall revenue growth, declining gross margins, and scant long-term FCF growth. That’s been the case for some time, though, and I think the market will need to see peace on the trade front and some evidence of momentum in the mobile and/or enterprise businesses before getting more bullish.

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Lenovo Facing Familiar Headwinds, And Still Frustrating Bulls

Lenovo Continues To Execute, But Also Continues To Suffer From Macro Headwinds

I noted in my last article on Lenovo (OTCPK:LNVGY) that the company’s lack of meaningful internal drivers was an impediment to building any real share price momentum and/or shrinking the valuation gap. Moreover, in the absence of meaningful internal drivers, Lenovo is subject to the vagaries of transient macro challenges, the latest being the increasingly global Covid-19 outbreak.

The ADRs are pretty much flat relative to that last article, even though the company delivered yet another better-than-expected quarter, despite a number of macro challenges including the ongoing U.S.-China trade war, supply/component shortages, and the aforementioned outbreak. Although the shares look undervalued on assumptions of low single-digit revenue growth, low-single-digit operating margins, and only minimal improvement in free cash flow margins, it will likely take real improvement in the data center or mobile business to meaningfully shrink that valuation gap.

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Lenovo Continues To Execute, But Also Continues To Suffer From Macro Headwinds

Lenovo Undervalued, But This May Be The New Normal

Lenovo’s (OTCPK:LNVGY) market-leading PC business looks well-placed to continue being a cash cow for the business, but management’s forays into the data center (servers) and mobile have proven to be poor capital allocation decisions. Although the data center business can likely do better in the future and the mobile business could outperform on attractive model launches, management really needs to show tangible results from its “3S” strategy if it wants to get the benefit of the doubt and better valuation multiples.

While I thought Lenovo could be due for some underperformance when I last wrote about the shares, the stock has suffered more than I expected from increased trade tensions between the U.S. and China in the interim, as well as weaker market demand for servers (particular hyperscale). Although Lenovo has consistently outperformed on margins, the market is not excited by a business still driven so significantly by the PC business. I do believe Lenovo shares are undervalued and offer a respectable dividend, but my enthusiasm for the shares is at least somewhat tempered by management’s inability to execute effectively with the server and mobile businesses.

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Lenovo Undervalued, But This May Be The New Normal

Lenovo Delivering On Its Promises And Outperforming As A Result

My bullishness on Lenovo (OTCPK:LNVGY) hasn’t been the most popular of my calls over the last year, but the company has made real progress delivering on its strategic goals and the shares are up more than 70% over the past year – well above the likes of HP (HPQ), Apple (AAPL), Acer, and Dell (DELL) – and have likewise outperformed strongly since my last update even before the big post-earnings run.

With the progress Lenovo’s made, I feel more comfortable easing up on some of the conservatism I’ve used in my modeling. I don’t think the shares are hugely undervalued, but there is still plenty of skepticism out there and the company has meaningful growth opportunities in its server business that augment a healthy core PC business.

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Lenovo Delivering On Its Promises And Outperforming As A Result

Lenovo Now Getting A Fairer Assessment From Investors

Two out of three isn’t bad. Lenovo (OTCPK:LNVGY) appears to be having some ongoing success in rejuvenating its PC business, while its server/data center business continues to grow on the back of its SDI and hyperscale efforts. Mobile is still a challenge, but the company has seen some shipment growth improvement in North America and has had some success with stripping costs out of this business.

Lenovo’s improving performance hasn’t gone unnoticed, and even with a sharp dive connected to worries about Chinese-government sponsored “hacking”, Lenovo has outperformed many of its consumer tech peers like Apple (AAPL) and HP (HPQ) since my last update on the company. While expectations are still relatively low for Lenovo, I don’t see the valuation as so unreasonable anymore, and I believe the next leg in the company’s performance will have to be driven by better margin performance in the non-PC operations.

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Lenovo Now Getting A Fairer Assessment From Investors

Two Encouraging, But Not Convincing, Quarters From Lenovo

Once again Lenovo (OTCPK:LNVGY) (992.HK) has delivered a better-than-expected set of quarterly financial results and once again many sell-side analysts are reacting with “yeah, well … I still don’t believe it”. That skepticism isn’t completely unfair, as Lenovo has struggled for some time now to translate its strategic and R&D decisions into real financial upside and quite a bit of the recent outperformance has been driven by cost reductions.

I remain in the “skeptical optimist” camp with Lenovo, and I continue to hold a relatively small position, as I believe the company still has leverageable brand value in PCs, not to mention an efficient product development and manufacturing system, and long-term upside in its Data Center Group business. I’m still looking for roughly 2% long-term revenue growth, sub-2% FCF margins, and high single-digit FCF growth as the company stabilizes the Mobile group and drives better results from its PC business.

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Two Encouraging, But Not Convincing, Quarters From Lenovo

Lenovo Looks Undervalued, But It Has To Rebuild Credibility A Quarter At A Time

Lenovo (OTCPK:LNVGY) is still struggling to find traction and restore its reputation. The shares down roughly 5% year-to-date, but down closer to 15% over the past year as investors and analysts remain disappointed and frustrated with the ongoing losses in the mobile business (and, to a lesser extent, the server business). Although a stronger than expected fiscal fourth quarter was a welcome bit of good news, Lenovo has to show that it can rebuild profitability in the PC business, drive the server business into the black, and at least stem the losses in mobile before the potential value of the company becomes a more relevant part of the conversation.

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Lenovo Looks Undervalued, But It Has To Rebuild Credibility A Quarter At A Time

Lenovo Making Progress, But It's Slow

Slow progress, sometimes frustratingly slow, continues to be the name of the game for Lenovo (OTCPK:LNVGY). Although there were signs of progress in the company’s fiscal third quarter (December) results, the ongoing operating challenges in the mobile business remain significant and there are no guarantees that the progress gained in the Data Center business can be held.

It hasn’t been very long since my last update on Lenovo, but since that time the shares have drifted about 5% lower, underperforming the Nasdaq and HP (HPQ) and basically matching Apple (AAPL) over that brief window. Stretch that window back a year or two, though, and the underperformance becomes much more apparent. That said, I don’t believe Lenovo is done for, and I believe expectations have been worn down to a point where Lenovo should be able to outperform in the coming years.

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Lenovo Making Progress, But It's Slow

A Drawn-Out Reset Of Expectations Should Lead To Better Days For Lenovo Shares

Lenovo's (OTCPK:LNVGY) bold and controversial decisions to try to work its PC magic in the mobile handset and server markets has thus far proved the doubters right. Margins have eroded since the acquisition of IBM's (IBM) x86 server business and Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Motorola business, and the share price has fallen by two-thirds from its mid-2015 high as investors have grown weary of the delays in transforming the acquired businesses into profitable contributors and grown more concerned about the long-term health of the PC business.

There are still valid reasons to worry that Lenovo shares could be a value trap, but expectations have been beaten down to a low bar. Lenovo's strategy to target higher-performance, higher-value markets in mobile and servers is a break with the company's past, but a logical one. What's more, management has not had to surrender much market share in PCs in its effort to support margins.

If Lenovo can grow revenue at a long-term rate between 2% and 3% and pull its adjusted free cash flow margins back up into the 2%-3% range, a fair value in the range of $15 to $17 still makes sense, even with a double-digit discount rate. The key question, though, remains whether or not the company can turn its mobile and server businesses into positive contributors (and/or jettison them) and restore investor confidence in Lenovo's business model and strategy.

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A Drawn-Out Reset Of Expectations Should Lead To Better Days For Lenovo Shares

Restructuring The Business Could Unlock Meaningful Value For Fujitsu

As I wrote about Fujifilm (OTCPK:FUJIY) last week, that company is a relatively rare example of a Japanese conglomerate that has moved reasonably quickly to transform itself in response to changing market realities. If Fujifilm is the "after" picture, Fujitsu (OTCPK:FJTSY) is more like the "before" picture, as weak profitability in its manufactured products continues to weigh down the margin and cash generation potential of its more competitive services operations. Fortunately, management is not blind to these realities and has already initiated a process to transform the business away from its legacy hardware operations.

As of now, the Street isn't buying the notion that Fujitsu will move itself away from low-to-no profit businesses like PCs, phones, servers, and chips and re-base itself around IT services. Even though I believe the business restructuring efforts will likely lead to no net long-term revenue growth (as growth in the IT services business is canceled out by sales and divestments), I think lifting the burden of these lower-margin businesses will allow for FCF margins to improve into the low-to-mid single digits, supporting a fair value more than 25% higher than today's price.

Readers should note that Fujitsu's ADRs are not particularly liquid. With that said, I would suggest investors consider buying the Japanese shares (6702.T); most of the better brokers now support international trading and the hassle/costs are not too onerous.

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Restructuring The Business Could Unlock Meaningful Value For Fujitsu

Seeking Alpha: Lenovo Looking To Have The Last Seat When The Music Stops

It's easy to dismiss Lenovo (OTCPK:LNVGY) right now. What sane management team would want to be in the PC business when shipments are declining at a double-digit rate? What sane management company would want to battle high-end smartphone champion Apple (NASDAQ:AAPL) and low-end dynamo Xaomi with the rusty blade that is Motorola at their side? Why would anybody think there's money to be made in a server business that IBM (NYSE:IBM) didn't want?

What I think many of the superficial analyses of Lenovo miss is that this is a company with a proven ability to squeeze blood from a stone and relentlessly drive costs lower. While PCs are likely never going to be a growth market again, I do think there's still an opportunity for Lenovo to gain share and take what growth is there. Likewise, I don't think Lenovo ever unseats Apple in smartphones, but I believe Lenovo's cost structure can allow it to be one of the last companies standing after the industry shakes out the weaker players. Finally, I think there's meaningful server growth opportunity in China and other emerging markets, and here too I believe Lenovo has an opportunity to benefit from stripping costs out of the IBM assets and running the business more cost-effectively.

I've decided to take a more negative view of Lenovo's revenue growth prospects, as the decline in PC shipments has been exceeding my expectations from a year ago and the smartphone market too has cooled more quickly than I expected. Nevertheless, even with a lower revenue growth rate, the opportunity to add around a point and a half to operating margin over time and a similar amount to FCF margin supports a fair value above $28.

Lenovo has to achieve its cost-reduction goals for the Motorola business on schedule to rebuild investor/analyst trust, but I believe Lenovo has seen the bottom in mobile and servers and will surprise with what it does over the next three to five years. More importantly, I think Lenovo has a cost structure and a cost philosophy that makes it a long-term survivor - as virtually every market eventually becomes a commodity market over time, cost leadership is ultimately what distinguishes the survivors and I believe Lenovo has the corporate DNA to be the last (or at least one of the last) players standing in PCs, x86 servers, and phones.

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Lenovo Looking To Have The Last Seat When The Music Stops

Seeking Alpha: Lenovo Facing Headwinds, But Managing Them Well

The core markets that Lenovo (OTCPK:LNVGY) serves haven't been in the greatest of health lately. PC sales continue to fall, and smartphone sales in China and large emerging markets have weakened. Despite that, the company continues to focus on building share and refining a lean model that keeps constant pressure on its rivals.

The key priorities for Lenovo's management need to be the improvements of the server business (acquired from IBM (NYSE:IBM)) and the mobile business acquired from Google (NASDAQ:GOOG). Both can support the company's basic functional value philosophy, but both need their cost structures further "Lenovo-fied". I continue to be bullish on the company's prospects for achieving these endpoints, but the shares aren't an obvious bargain today.

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Lenovo Facing Headwinds, But Managing Them Well

Seeking Alpha: Lenovo's Strong Operating Results Likely Won't Quiet The Doubters Yet

I expect that for any sufficiently large company, there will inevitably be analysts and investors who are negative on the stock. In the case of Lenovo (OTCPK:LNVGY), though, I continue to be surprised at the conviction expressed by the bears that Lenovo will fail to successfully integrate and improve the x86 server business it acquired from IBM (NYSE:IBM) and the Motorola phone operations it acquired from Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and somehow lose its touch in the PC business along the way.

Skepticism is fine; healthy, even. In the case of Lenovo, I think it also points to an ongoing opportunity for the shares to perform. I believe that Lenovo can continue to leverage its leading position in PCs and use its extensive operating leverage to reduce costs in the IBM server business. I'm less certain that Lenovo can break out from the pack and become a #3 smartphone player with enough leverage to seriously threaten Samsung (OTC:SSNLF) or Apple (NASDAQ:AAPL), but I nevertheless do believe that the company's mobile operations are a long-term growth opportunity.

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Lenovo's Strong Operating Results Likely Won't Quiet The Doubters Yet

Seeking Alpha: Lenovo Doing Fine On Its Own

The acquisitions of IBM's (NYSE:IBM) x86 server business and Google's (NASDAQ:GOOGL) Motorola Mobility business are certainly important parts of Lenovo's (OTCPK:LNVGY) investment outlook today, but fiscal first quarter results are a good reminder that there's a strong business here all on its own. Management continues to drive shares gains in PCs and smartphones throughout the world while simultaneously keeping firm control on operating expenses. While there are still risks attached to closing and integrating the IBM and Motorola deals, there are also opportunities for Lenovo to do even better than expected. I look at those factors as pretty balanced today and would suggest waiting for a pullback before starting a sizable position here.

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Lenovo Doing Fine On Its Own

Seeking Alpha: Lenovo Making The Right Strategic Moves To Build Value

Lenovo (OTCPK:LNVGY) has come along nicely since I wrote about the company as a Top Idea in late July of 2013. Up more than 30%, Lenovo has done well on continued PC, handset, and tablet growth. The shares were rocked when Lenovo followed up the long-expected acquisition of IBM's (IBM) x86 server business with the not-nearly-so-expected acquisition of Motorola from Google (GOOG). Integrating one damaged business was doing to be hard enough, but now Lenovo is paying more than $5 billion for two sizable businesses that need a lot of TLC to turn around.

I continue to be bullish on Lenovo (and a shareholder), as I believe the company does have relevant experience in integrating large acquisitions. What's more, I think the IBM and Google deals address a lot of the remaining deficits in Lenovo's portfolio from a strategic perspective, while Lenovo's demonstrated capabilities in sourcing, manufacturing, and distribution efficiency can fix a lot of what ails these businesses. With a fair value in the high $20s on an elevated discount rate, I continue to believe Lenovo can be a good stock from here.

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Lenovo Making The Right Strategic Moves To Build Value

The Motley Fool: Lenovo Group Ltd: Taking Short-Term Pain For Long-Term Gain

Chinese PC, smartphone, and tablet manufacturer Lenovo (NASDAQOTH: LNVGY  ) has a knack for surprising analysts and investors that goes back a while. Lenovo defied skeptics who thought its acquisition of the IBM (NYSE: IBM  ) PC business was a losing move, leveraging that deal to build the world's largest PC business and continuing to grow its PC business at a time when the market is shrinking.

Now Lenovo is doubling down in a big way. The company's acquisition of IBM's server business was well-telegraphed and well-liked, but then the company shocked the market with the nearly $3 billion acquisition of Motorola Mobility from Google (NASDAQ: GOOG  ) . The latter has proven quite controversial, with some sell-side analysts speculating that Lenovo will never turn Motorola around and the shares down around a quarter since the announcement.

I believe that the near-term skepticism ignores the substantial long-term opportunities at Lenovo and some significant undervaluation in these shares.

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Lenovo Group Ltd: Taking Short-Term Pain For Long-Term Gain

The Motley Fool: Are Lenovo And IBM Finally Close To Another Deal?

It has taken a long time, but Lenovo (NASDAQOTH: LNVGY  ) and IBM (NYSE: IBM  ) may be about to finally strike a bargain for IBM's x86 server business. Lenovo has openly acknowledged its interest in this business, but the companies have been at odds on deal terms. With ongoing share loss in the server business and a desire to reallocate capital to higher-returning businesses like software and services, IBM would do well to close this deal.

The good news for Lenovo is that it can do well with or without IBM's server business. The company has built the No. 1 PC business in the world and has already grown its tablet and smartphone business to be No. 4 in terms of market share, without aggressively targeting the U.S. Lenovo looks meaningfully undervalued, and sealing a deal with IBM would only help matters.

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