Lenovo:Expense for L/T quality growth

Lenovo announced on Sep 30 to sell and lease back its research building inBeijing with a disposal gain of US$205m. We talked to management and seean ongoing restructuring in the mobile segment. We thus trim FY2017E netincome by 12% on a lower smartphone shipment and higher opex ratio onmarketing and R&D. New PT at HK$8.0 with unchanged PE multiple of 13x.

Ongoing restructuring in the mobile segment: Management guided a oneoffdisposal gain from building sales will be largely offset by one-off expenseson employee layoff in the mobile segment. The layoff expenses and numberof employees have not yet disclosed. We see the new layoff program and thedelay of Phab 2 Pro (global first AR smartphone; was announced to release inSep) as a signal of management’s ongoing efforts in rebuilding the mobilebusiness. We thus trim FY2017E net income by 12% on lower smartphoneshipments and higher opex ratio on marketing and R&D.

Smartphone; difficult but on the right path: Despite ongoing restructuring,we are positive to the strategy of moving up to high-end smartphone models,transferring from operator channels to open retail and online channels andenhancing brand awareness. As we highlighted in Aug (Continuousenhancement, link, Aug 18), management have seen both ASP and GMimproving sequentially in the smartphone segment in FY1Q17A, implying therestructuring is having an effect. We believe the expense will allow Lenovo toenjoy sustainable and quality growth in the long term.

PC; sustainable cash cow: PC contributed 66% of revenue in FY2016A andwe see it as a sustainable cash cow for Lenovo given its leading position inthe consolidated and saturated PC industry, which is squeezing out smallervendors and benefiting the larger players. The company’s PC global marketshare remained above 19% for 8 consecutive quarters with pretax marginsremaining above 5.0%.

Enterprise; small but growing: Enterprise contributed 10% of revenue inFY2016A and we expect it to grow to 13% and 25% of revenue in FY2017-18E driven by strong growth in hyper-scale products in China and the newfast-growing hyper-converged products.