Why the stock price plummeted: Lenovo has fallen into the pain period of profit transformation

Recently, Lenovo released its interim financial report for the 2014 fiscal year. From the end of June to the end of September 2014, Lenovo's revenue reached 10.475 billion US dollars, a 7% increase over the same period last year, and its net profit increased by 19% over the same period last year, reaching 262 million US dollars. Despite the outstanding performance, its stock price still fell by about 5%. So the question is, what exactly caused Lenovo's stock price to plummet after the seemingly outstanding financial report?

From the above financial report, although Lenovo's revenue increased year-on-year, it was lower than Wall Street's expectations, and the growth rate was the lowest in six quarters. The main reason for its revenue not meeting expectations was that the revenue of its mobile business, which is an important part of its PC strategy, including smartphones and tablets, fell by 6% year-on-year. However, in contrast to the year-on-year decline in revenue, Lenovo's smartphone and tablet shipments increased by 38% and 30% respectively in the same quarter. The significant increase in shipments but the decline in revenue, on the one hand, shows the fierce competition in the smartphone and tablet markets, and on the other hand, it is attributed to Lenovo's implementation of the strategy of exchanging revenue (including profit) for market scale.

Nevertheless, in terms of scale, Lenovo's smartphone shipments and market share (excluding the shipments of Motorola Mobility mobile phones acquired through mergers and acquisitions) were still surpassed by Chinese manufacturer Xiaomi in the past quarter in the Chinese and global smartphone markets. This not only shows the challenges Lenovo's own mobile phone business faces in terms of scale, but also proves the necessity and timeliness of its acquisition of Motorola Mobility. Because if the shipments of the acquired Motorola Mobility mobile phone business are taken into account, Lenovo still ranks among the top three in the global smartphone market with a market share of 8.7%, and has once again widened the gap with its competitors in terms of scale.

We have been emphasizing Lenovo's scale advantage in the smartphone market because Lenovo is best at winning by scale, or first gaining scale and then improving profits (even if the profits are very low) through supply chain management and integration, and finally occupying the leading position in the industry. This has been fully demonstrated by its rise in the PC industry. Therefore, whether Lenovo can grasp the industrial scale advantage in the competition is related to the prospects of Lenovo's development in the industry, and even its success or failure. This is especially true in the mobile business represented by smartphones, which is related to the success or failure of Lenovo's PC+ strategic transformation.

According to the summary and forecast of the operating profit margin of smartphone manufacturers released by investment bank Merrill Lynch in October this year, Lenovo's operating profit margin this year is only 1%, far lower than its main competitors Xiaomi and Huawei (operating profit margins are both in the high single digits), and this trend will continue from 2015 to 2017. What worries investors more is that its acquired Motorola mobile business is currently in a loss-making state, and may still be in the red even in 2015-2017, with an optimistic forecast of break-even. It can be seen that Lenovo's mobile phone business will face great challenges in the future, which also shows the strategic significance of Lenovo maintaining the scale of its mobile phone business (increase in shipments and market share and leading its competitors) in the next few years. That is, to make up for the low profit margin with a larger shipment volume and market share, and then ensure the growth of overall profits (small profits but quick turnover).

Of course, predictions are just predictions, and Lenovo itself is not unaware of this challenge. For example, as early as the first half of next year, it plans to move Motorola mobile phone production to its Lenovo Mobile Internet Industrial Base in Wuhan for production, and establish a new subsidiary to launch an independent terminal brand based on Internet marketing. These are undoubtedly all aimed at reducing costs while increasing scale and improving profitability. For example, the Lenovo Internet Industrial Base in Wuhan can greatly enhance Lenovo's independent production and manufacturing capabilities, while making the supply chain run faster and more efficient, and making costs and innovations more competitive. However, all of these require a process, and in this process, Lenovo must ensure the momentum of scale growth to buy time for its transformation from scale to profit. The performance of Lenovo's mobile business is bound to be under pressure in this process, that is, revenue and profit, especially profit, may suffer consecutive quarterly losses, thereby dragging down Lenovo's overall performance.

Similarly, in the enterprise-level business of Lenovo's PC+ strategy, with the completion of the acquisition of IBM's X86 server business, it has become the world's third largest and China's largest server manufacturer, and has acquired its scale advantage. However, similar to the mobile Internet smartphones, due to the previous decline in revenue and profit of IBM's X86 server business, coupled with its own average performance in the server market, its revenue and profit, especially the profit that Wall Street pays attention to, will also suffer similar transition pains in its own smartphone industry.

According to the revenue ratio of each business segment in Lenovo's latest quarterly financial report, its enterprise business (including cloud services) only accounts for 2%-6% of its overall revenue, that is, between US$210 million and US$630 million. Based on Lenovo's plan to strive to achieve an annual revenue of US$5 billion (an average of US$1.25 billion per quarter) in the next year, it is not difficult to find that the revenue of IBM's X86 server business is 2-6 times that of Lenovo's own enterprise business. It can be said that without the acquisition of IBM's X86 server business, Lenovo's enterprise business can be almost ignored, and its market share, shipments, revenue, etc. are difficult to say. This also proves from the side that the core and primary purpose of Lenovo's acquisition of IBM's X86 server business is to make its enterprise business have scale. However, given the current decline in shipments, revenue and profits of IBM's X86 server business, Lenovo still faces the challenge of reducing costs, optimizing the supply chain and increasing profits while maintaining and expanding its scale in the future, and this also takes time.

In summary, given the stabilization of the PC industry and Lenovo's established leading edge in the PC industry, its future profit growth will rely more on mobile (such as smartphones) and enterprise businesses. With the completion of the acquisition of Motorola Mobility and IBM's X86 server business, Lenovo already has scale advantages in the above two industries. However, since the acquisition targets have been in a period of declining revenue and profits, or even losses, Lenovo, which has gained scale advantages, is bound to enter a period of pain in the transformation of scale and profits, and this period of pain will cause negative pressure and uncertainty on Lenovo's performance for a certain period of time. This is also the main reason why Lenovo's latest quarterly performance is good, but its stock price plummeted. However, judging from the process and experience of Lenovo's PC development to the final top, large-scale operation or first scale, and then seek profit or profit margin growth is Lenovo's killer, which also reminds Lenovo that its future integration strategy should focus on expanding business scale.

As a winner of Toutiao's Qingyun Plan and Baijiahao's Bai+ Plan, the 2019 Baidu Digital Author of the Year, the Baijiahao's Most Popular Author in the Technology Field, the 2019 Sogou Technology and Culture Author, and the 2021 Baijiahao Quarterly Influential Creator, he has won many awards, including the 2013 Sohu Best Industry Media Person, the 2015 China New Media Entrepreneurship Competition Beijing Third Place, the 2015 Guangmang Experience Award, the 2015 China New Media Entrepreneurship Competition Finals Third Place, and the 2018 Baidu Dynamic Annual Powerful Celebrity.