LENOVO GROUP CHAIRMAN YANG YUANQING WAS WORKING AT the company’s North Carolina offices and spending a good deal of his time studying English and taking executive courses when his longtime mentor, Lenovo founder Liu Chuanzhi, urged him to return to Beijing and retake the helm as CEO of the personal computer maker.
It was February 2009, and Lenovo was stumbling badly on its way to posting a $226 million loss for the financial year ended March 31, 2009. The deficit was an embarrassing setback for a company that only four years earlier had acquired IBM Corp.’s personal computer division for $1.75 billion in one of the boldest attempts ever by a Chinese company to establish itself as a global brand. Liu and Yang, as chairman and CEO, respectively, of Lenovo’s owner, Legend Holdings, had recruited William Amelio, former head of Dell’s Asia-Pacific operations, to serve as chief executive. The combination of Chinese financial and manufacturing muscle with American management and technology seemed like a sure winner.
The result was much different, though. Lenovo had acquired a deteriorating, high-cost business whose weaknesses were exposed brutally when the financial crisis triggered a global recession in late 2008. Major corporations slashed information technology budgets to cut costs, hurting companies like Lenovo, whose ThinkPad line had dominated the commercial PC market. Lenovo was late to enter the consumer segment, where rivals like Apple, Hewlett-Packard Co. and Taiwan’s Acer prospered with sleek new models and strong marketing. The company would need major surgery to stanch the red ink and restore growth.
Replacing Amelio as CEO, Yang immediately set out to reshape the business. He laid off more than 2,500 people, or 11 percent of the company’s global staff, with the cuts falling hardest on its U.S. operations. He de-emphasized sales in developed markets and refocused Lenovo on China, where it has long been the leading computer maker, and other emerging markets. And Yang moved to broaden the company’s product line by developing a range of what he calls PC-plus products, including smartphones, tablet computers and digital televisions.
“We protect, and we attack,” he told Institutional Investor in a recent interview in his conference room, overlooking a garden at Lenovo’s leafy, campuslike headquarters in Beijing. “We protect our market leadership in China and the global enterprise PC business, where we are No. 1, and we attack global emerging markets and the global consumer PC business. We are focused on growth.”
Yang’s formula has delivered impressive results. Lenovo swung back into the black in 2009 and has posted increasing profits for nine consecutive quarters. It has boosted its PC market share, rising from the No. 4 position to No. 2, and is poised to overtake HP as the global leader by the end of this year, according to International Data Corp., a Framingham, Massachusetts–based technology analysis firm. The company now generates 30 percent of its international revenue from consumer PCs, up from 20 percent in 2009, according to CFO Wong Wai-ming.
“Lenovo is coming on strong,” says Bob O’Donnell, the San Mateo, California–based vice president for clients and displays at IDC. “The company is 100 percent focused on market share. They want to be No. 1, and they will do everything possible to get there.”
Yang and his team still face plenty of challenges. The company is climbing to the top of the PC market at a time when some analysts think the sector’s best days are over. Mobile computing is becoming dominant, and although Lenovo is ramping up its offerings of smartphones and tablets, those are hypercompetitive segments in which Apple and Samsung Electronics Co. reap most of the profits. Notwithstanding the company’s recent string of profits, Lenovo generates some of the leaner profit margins in the industry.
“Profitability has been Lenovo’s biggest hurdle,” says Thompson Wu, a Taipei, Taiwan–based analyst at Credit Suisse.
Yang and Wong admit that the company’s pretax profit margin of just under 2 percent of sales is wafer thin — half of HP’s — and that they’ve got to work harder on improving the bottom line.
Still, Lenovo has come a long way from the gloom of 2009, and Yang is determined to build on the company’s momentum. He sees acquisitions as a way to increase Lenovo’s presence in international markets, and he believes higher volume will enable the company to generate fatter margins.
In September the company acquired CCE, Brazil’s largest maker of computers and other electronic goods, for 300 million reais ($148 million). The deal raises Lenovo to the No. 3 spot in Brazil’s PC market. Last year the company paid $450 million for a 51 percent stake in a joint venture with NEC Corp. that will make Lenovo the largest PC manufacturer in Japan and give it access to NEC technology and engineering talent for smartphones, tablets and digital TVs. In another 2011 deal Lenovo acquired 61 percent of German electronics maker Medion for $738 million. The purchase doubled Lenovo’s share of Europe’s largest PC market, to 14 percent. More deals could be in the offing.
“We will always be interested in strategic opportunities,” says Milko van Duijl, the company’s Hong Kong–based president for the Asia-Pacific and Latin America, who engineered the three deals. “We want local knowledge, presence, local share, routes to market and a brand name that is important.”
Such deal making has helped Lenovo more than double its sales since 2005. Revenue grew by a robust 37 percent in the financial year ended March 31, to $29.6 billion, and net income jumped 73 percent, to $473 million. (The company reports results in both U.S. and Hong Kong dollars.) In the most recent quarter, ended June 30, sales were up 35 percent at $8 billion, and net income rose 30 percent, to $141 million. Lenovo sold 12.8 million desktop and notebook computers in the period, only 609,000 units behind HP, for 14.9 percent of the global market. It was trailed by Dell with 11.3 percent, Acer with 10.8 percent and Taiwan’s Asustek Computer with 6.9 percent.
The company’s Hong Kong–listed stock has risen along with profits. Shares traded at HK$6.50 (84 cents) late last month, up 34.6 percent in the past 12 months. Aside from Legend, which owns 33.58 percent of Lenovo, Yang is the largest individual shareholder, with a 8.4 percent stake.
Investors and analysts have welcomed Lenovo’s turnaround. Sell-side analysts ranked Yang as the best CEO of an Asian company in the Technology/Hardware sector of Institutional Investor’s 2012 All-Asia Executive Team, and both buy- and sell-side analysts voted Wong the best CFO.
“We believe that Lenovo’s management team is very capable of executing its M&A goals, which will position Lenovo to continue to gain market share and expand margins despite the sluggish growth outlook in the PC space,” says Michael Reynal, a Des Moines, Iowa–based portfolio manager at Principal Global Investors, which owns roughly $10 million worth of the company’s shares.
Lenovo’s rise is more than a corporate success story. It demonstrates the powerful potential of China Inc. to expand beyond low-end manufacturing and develop global brands. The company also reflects the uniquely hybrid nature of most of corporate China: It is a product of a Communist Party–ruled state — the government still owns 36 percent of its parent, Legend — but it competes vigorously in the global market.
LENOVO COMES FROM HUMBLE ORIGINS. Liu and ten colleagues from the computing laboratory at the Chinese Academy of Sciences, the State Council’s scientific advisory body, founded a company called New Technology Development in 1984 with 200,000 yuan (then worth $25,000) in capital from the academy. After a failed attempt at importing TVs, Liu and his team developed a circuit board to enable IBM-compatible PCs to process Chinese characters. The company, which they renamed Legend, introduced its first PC in 1990 and quickly grabbed leadership of the Chinese market; it has 35 percent of the market today. Liu launched the Lenovo brand in 2003 to spearhead a push into the international market.
The company’s growth in China was certainly impressive, but the IBM acquisition took Lenovo to a whole new level. Before the deal the company had 10,000 employees, working only in China. Today it employs 27,000 and has three global bases: Beijing, the corporate headquarters, where Yang is based; Hong Kong, where Wong and his finance team reside and Lenovo is listed; and Morrisville, North Carolina, home of the former IBM business, where Lenovo employs some 6,000 people in R&D, marketing and sales. Fewer than 50 percent of staff with the rank of vice president or above are Chinese, and the company has adopted English as its official language.
The transformation from a Chinese to a global corporate culture hasn’t been an easy one, though. Yang recalls that Lenovo would always send a car and driver to pick up U.S. staff from their hotels when they visited China, but when he traveled to the U.S., he and his staff had to arrange their own rides to Lenovo’s offices.
Early meetings were often a clash of cultures between Lenovo managers, steeped in the company’s top-down management style, and the newly acquired IBM managers, whose corporate culture emphasized creativity and free thinking, says Eugenie Lai, general manager of China business development at consulting firm Towers Watson. “Lenovo management would show up at meetings well after their lower-level staff were assembled, and staff typically wouldn’t even dare to speak until told to speak,” she says. “Many Lenovo staff simply were uncomfortable in meetings with their IBM counterparts, who asked questions and even gave unsolicited commentary on management policies.”
In the end, Lenovo absorbed a large dose of IBM’s culture, says Lai. The company abandoned the common Chinese corporate practice of making staff who show up late to meetings stand in a corner for several minutes as punishment, because it realized it couldn’t get away with humiliating American staff, company insiders say.
“We spend a lot of time on culture, creating an identity,” says van Duijl. “We boil it down to five P’s: planning, performance, practice, prioritization and pioneering. Everyone is very comfortable and knows what their goals are in their categories. We bridge East and West with this, even though Western and Eastern cultures are different.”
Yang says the company now encourages its Chinese staff to speak up at brainstorming sessions, fostering greater creativity. “We must follow the rule of mutual respect, compromise,” he explains. “The corporate cultures of IBM and Lenovo were as different as Chinese versus American culture. But in the end, we found ways to cope and cooperate.”
The CEO is the son of rural surgeons in Hefei, the capital of Anhui province, one of the most backward regions of China despite its proximity to Shanghai. He studied his way to success, earning a bachelor’s degree in computer science from Shanghai Jiaotong University and a master’s from the University of Science and Technology of China, in Hefei.
Hired as a sales manager by Legend in 1989, Yang’s first notable project was to help Liu write a proposal to IBM to make Legend its sales agent in China. The effort failed, but Liu and Yang later succeeded in becoming the Chinese distributor for Hewlett-Packard. Yang rose through the ranks to become president and CEO in 2001.
He stepped up to chairman after the IBM acquisition, and Amelio came on board as CEO to manage the integration. IBM’s PC business had a high cost structure and was already losing money, while Lenovo’s Chinese business was solidly profitable. The 2008 financial turmoil and resulting recession turned a difficult transition at Lenovo into a crisis. Executives say weakness in the PC market exposed a lack of balance in Lenovo’s operations.
“In 2009, China was 70 percent of group profits,” CFO Wong says in an interview at his Hong Kong office. “Now it is just 40 percent. We also lacked balance outside of China. We were too dependent on enterprise business.” Sales to corporate customers accounted for 80 percent of sales, while the consumer segment generated only 20 percent, he says. The company has shifted that mix by 10 percentage points over the past three years. “We want to drive a more balanced business and not depend only on one country or one segment,” says Wong.
To improve that balance, Yang’s first step after returning as CEO was to separate the business into two lines, emerging markets and developed markets, and install the company’s Asia-Pacific chief, Chen Xudong, to lead the former.
The emphasis on emerging markets proved timely. Global PC sales have slowed in the past two years, partly because of the rise of tablets as an alternative computing device, which is largely a phenomenon of developed markets, says Wei Chen, a technology analyst at Citigroup in Taipei. In emerging markets most consumers are still first-time PC buyers.
“Lenovo’s key competitors — HP, Dell and Acer — are being negatively affected by tablets, while Lenovo continues to outgrow the industry,” says Chen. “This has put Lenovo in a virtuous cycle: As its competitors generate less profits, they are further weakened in their ability to compete in emerging countries. This trend should continue.”
The string of acquisitions in Germany, Japan and Brazil over the past year has given another impetus to growth. “They have been very methodical in figuring out where they can leverage their brand and where they can grow through acquisition,” says IDC’s O’Donnell. “By buying a local company, they are avoiding big tariffs. They also are gaining local factories.”
The emerging-markets push has given a fillip to Lenovo’s PC business. The company isn’t standing pat with its existing lineup, however. He, the CTO, has been focusing a lot of the group’s research and development on new products to fulfill Yang’s PC-plus strategy. He oversees a staff of about 3,200 R&D engineers, including about 300 in Japan who work at the company’s joint venture with NEC and 300 in the U.S., mostly in Morrisville. Lenovo spends about $450 million a year, or 1.5 percent of revenue, on R&D.
The company has launched its own line of tablets in China and in select global markets, including the U.S. Key models include the IdeaTab, a consumer-oriented Android tablet that sells for less than $200, and the ThinkPad Tablet 2, a model aimed at professionals that is expected to sell for $629 when it is launched later this month. It will feature Intel Corp.’s new Atom Z2760 processor and Windows 8, the latest version of Microsoft Corp.’s operating system.
Lenovo is counting on the new product to give it a boost in the brutally competitive tablet sector. The company ranked sixth on a worldwide basis in the second quarter, but it delivered just 1.4 percent of the 26 million tablets sold in the period, according to IDC. Lenovo has a long way to go to catch up with global leader Apple, No. 2 Samsung and No. 3 Amazon.com.
More innovatively, the company is seeking to bridge the gap between notebooks and tablets with a distinctive new product, the IdeaPad Yoga 13. Slated to be launched in the U.S. later this month to coincide with the introduction of Windows 8, which it employs, the Yoga can be used as a conventional laptop with a keyboard, but the screen can be folded backward to turn the device into a touch-screen tablet. The dual functionality won’t come cheap: The Yoga is expected to retail for a little more than $1,000, far higher than the average tablet and more than many laptops.
“We will not do ‘me-too’ products,” says CEO Yang. “We want to innovate. We want to lead. Take the Yoga: It can be a laptop or a tablet. It’s a convertible product.”
Early buzz about the hybrid model has been positive. Jarred Walton, who reviews technology products at AnandTech.com, a popular technology site, praises the Yoga’s sleekness compared with other laptops with touch screens, which can be as much as 20 millimeters thick. “Lenovo’s IdeaPad Yoga 13 includes a touchscreen, but it still comes in at just 17mm thick,” he wrote recently. “It also manages to do all this without sacrificing battery life, as Lenovo still rates the Yoga for over eight hours of battery life. Things get even better from there, as not only do you get a touchscreen, but it uses an IPS panel. Hallelujah!” In-plane switching technology offers clearer images from wider angles than conventional liquid crystal displays and doesn’t distort images when touched.
Smartphones are another key target for Lenovo, and it has plenty of ground to make up. The company ranked ninth in the second quarter, with 3.2 percent of the global market of 155 million units, according to IDC. Most of the company’s sales come in China, where Lenovo ranks second, just behind Samsung, with 11.2 percent of the market.
“We have to try to be No. 1 in China in smartphones,” says CTO He. “This is the future of computing. China is very important to us. This is our home market.”
Lenovo released its first smartphone, a relatively low-end Android model named LePhone, in China, India and Pakistan last year. “What we often do is test-market in China first, but we launch globally,” says He.
Now the company is embarking on an ambitious upgrade. In May it introduced the LePhone K800, one of the first smartphones to use Intel’s Medfield chip. The phone, which has a 4.5-inch screen, sells for $520 in China, about 20 percent less than the Apple iPhone 4S. In August, Lenovo provided previews of the K860, a five-inch model with a faster quad-core processor that aims to compete with Samsung’s popular Galaxy model.
“The smartphone market in China could be an attractive new business opportunity for Lenovo,” says Principal Global Investors’ Reynal. “Many more competitive new models are expected to launch, with management guiding a significant growth to 15 million to 20 million units this year. This segment demonstrates Lenovo’s capability to extend outside the PC market and should provide upside to their bottom line.”
Investors would certainly appreciate that, for Lenovo has yet to translate its market-share gains into healthy profit margins. CFO Wong says the company aims to double its pretax profit margin, to 4 percent of sales. He points to the strides Lenovo has made since Yang returned as CEO. “You should go back two to three years ago, when Lenovo suffered an operating loss of $200 million,” he says. “You have to acknowledge that we’ve come a long way. We regrouped ourselves. No business can turn around with increased business and a higher margin in a short period of time.”
Lenovo has deliberately sacrificed profits to focus on driving sales growth, particularly in PCs in emerging markets and the smartphone business in China, says Citigroup’s Chen. He sees margins expanding as those two businesses gain scale and become profitable. Chen estimates that Lenovo’s PC business in emerging markets approached breakeven in the June 30 quarter, compared with a loss of about $100 million in the same period a year earlier, while losses in smartphones are running at a modest rate of about $20 million a quarter.
“If Lenovo executes correctly, their corporate average margin could double in one or two years from now,” he says. The company’s current 2 percent profit margin is “much lower than its true earnings potential,” Chen adds.
Credit Suisse’s Wu is equally optimistic. “We believe Lenovo’s momentum will continue to improve,” he says. “Near-term we expect Lenovo to become the largest PC vendor sometime this year through global share gains outside of China. Its relatively new smartphone business has found significant traction in China, and we expect a rollout in other emerging Asia-Pacific countries soon.”
Introducing so many new products in such hotly contested fields while expanding the company’s geographic footprint won’t be a simple task, but Lenovo executives insist that the two prongs of their strategy go hand in hand.
“Our future is in China, the U.S., Brazil, India, Russia,” says Wong. “We want to by and large reflect the industry mix but skew toward high growth so we can continually outperform the industry in terms of margins.”
For Lenovo’s CEO the turnaround achieved so far provides more than enough grounds for confidence.
“We believe in our own abilities,” Yang says. “We know our own strategy and our strengths. We believe we can outgrow our rivals for years to come. The bottom line is this: We believe we can win, and we will win.”
