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Lenovo Group Summary

Core Content Overview

Lenovo Group (992 HK) is a Hong Kong-listed technology company with a current share price of HKD8.63 and a target price of HKD8.00, representing a 7% decrease. The company has a market capitalization of USD11.6 billion and an average daily trading volume (ADTV) of USD65 million. The stock is currently rated as HOLD by Maybank Kim Eng.

Main Points and Key Information

Earnings and Valuation Adjustments

• Target Price Revision: The target price was reduced from HKD12 to HKD8 due to a 17% and 11% decrease in FY15/16 earnings forecasts and a lower TP multiple to 12x PER from 15x previously.
• Earnings Assumptions: The earnings forecast for FY15 is USD48.6 billion, and for FY16, USD56.3 billion. The company expects a 25–30% YoY revenue growth in FY15 and 15–20% in FY16.
• Earnings Impact: The acquisition of IBM's server business and Moto's smartphone business is expected to impact the earnings structure. The combined effect of share dilution and integration challenges leads to a potential decrease in ROE to low-20% from mid-20%.

Revenue Mix and Forecast

• Revenue Breakdown: The revenue mix is expected to shift significantly. PC sales are projected to decrease from 78% in FY14 to 66% in FY15 and 60% in FY16, while smart devices are expected to increase to 24% in FY15 and 26% in FY16. Servers are projected to rise to 10% in FY15 from 6% in FY14.
• Earnings per Share (EPS): The core EPS is forecasted to be 8.2 cts in FY15 and 9.9 cts in FY16. The net profit is expected to rise from USD635.1 million in FY13 to USD1,108.5 million in FY16.

Moto Acquisition Analysis

• Challenges: Moto's smartphone operations are loss-making and have struggled to gain market share from Apple and Samsung, which dominate the premium segment in the US.
• Financial Performance: Moto reported an operating loss of USD1.12 billion in FY13 (US GAAP: USD2.34 billion) on revenue of USD4.44 billion. The company is expected to reduce losses to USD347 million in FY15 and USD200 million in FY16.
• OPEX and Margin: Moto's OPEX is expected to decrease by 25% YoY in FY15 and further by 2015F. However, the operating profit margin (OPM) is expected to remain low due to higher capex and operating costs.
• Goodwill Concerns: The acquisition of Moto is expected to increase goodwill from USD3.33 billion to USD5 billion in FY15. This may lead to potential write-downs if the business fails to perform as expected.

Share Dilution and Equity Impact

• Share Issuance: A total of 800 million new shares will be issued due to the acquisitions, including 182 million for IBM and 618 million for Moto.
• Equity Adjustment: The equity base is expected to increase, which may lead to a lower ROE. The adjusted net gearing could rise to 50% from the current adjusted net cash of HKD1.30 per share.

Balance Sheet and Cash Flow

• Funding Sources: The acquisitions are funded by a combination of cash and stocks. IBM's server acquisition is partially funded by USD2.1 billion in cash and USD230 million in stocks, while Moto's smartphone business is funded by USD660 million in cash and USD750 million in stocks.
• Balance Sheet Projections: Post-acquisition, the company's total assets are expected to rise to USD31.0 billion in FY16. The cash and short-term investments are projected to decrease to USD3.2 billion, while interest-bearing debt is expected to increase to USD5.06 billion.
• Liquidity: The company's liquidity is impacted by rising working capital requirements, especially if it reverses its outsourcing strategy for Moto.

Financial Metrics

Market Position and Challenges

• Market Share: Lenovo aims to secure No.3 global market share in the smartphone market, but it faces significant challenges from Apple and Samsung, which control 65–70% of the US market.
• Market Share Trends: Moto's US market share dropped from 9.8% in Sept 2012 to 6.7% in Dec 2013, while Apple and Samsung increased their share to 67.9% in the same period.
• Strategic Challenges: The high OPEX and low OPM for Moto make it difficult to generate profits. The company needs to reduce costs and increase market share in the highly competitive US market.
• Industry Dynamics: The high-end smartphone market is saturated, and price competition is expected to increase. Moto's aggressive marketing and product innovation have not been enough to recover market share.

Conclusion

Lenovo Group is undergoing significant changes due to the acquisitions of IBM's server business and Moto's smartphone division. These changes are expected to impact its financial performance and valuation. The company faces challenges in integrating the acquired businesses and achieving profitability in Moto's operations. Despite the potential for growth, the target price has been lowered, and the company's ROE is expected to decline. The balance sheet and cash flow are also affected by the share dilution and increased liabilities. Overall, the outlook for Lenovo remains cautious due to the uncertainties associated with the acquisitions and the competitive smartphone market.