Lenovo Beats the Market and HP

Christopher is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Eight years ago, Beijing-based Lenovo (NASDAQOTH: LNVGY.PK) purchased IBM's personal computer business for $1.25 billion. Lenovo has greatly benefited from IBM's ThinkPad brand, international sales/distribution channels, and advanced PC manufacturing technologies. IBM's resources enabled Lenovo to pursue growth in foreign markets and attract new customers and investors outside of China. Since then, Lenovo has pushed ahead of Hewlett-Packard and Dell to become the world's largest PC supplier.

<img alt="" src="http://g.fool.com/editorial/images/59236/lenovo-relative-to-hang-seng-index_large.png" />
This illustrates Lenovo's stock outperforming the Chinese benchmark Hang Seng Index. Source: Bloomberg

Worldwide PC shipments

Worldwide PC shipments totaled 75.6 million units in the second quarter, down 11.4% from the same period a year ago, according to data compiled by International Data Corp. (IDC). This marks the fifth consecutive quarter of PC shipments declines, the longest in PC shipment history.

Some have placed the blame on Microsoft's (NASDAQ: MSFT) Windows 8 operating system for the recent PC sales slump. Windows 8 disappointed some users, but it was not a failure, nor the sole reason for the lack of PC growth, as suggested by Samsung executives. PC shipment declines show the growth and popularity of smart connected devices such as tablet computers in developed and emerging markets.

In 2013, IDC expects the average sales price of tablets to decrease to $381. Tablets present attractive price points for price-sensitive consumers who can't afford a PC with an average sale price of $635.

“In emerging markets, inexpensive tablets have become the first computing device for many people, who at best are deferring the purchase of a PC. This is also accounting for the collapse of the mini notebook market,” said Mikako Kitagawa, an analyst at market research firm, Gartner.

<img alt="" src="http://g.fool.com/editorial/images/59236/regional-growth_large.png" />

This illustrates PC market growth in developed and developing markets from Q12011 to Q12013. Source: Gartner

According to Gartner, Windows 8 adoption has evolved quicker than previous Windows versions. With the new Windows 8.1 update coming later this year, Microsoft ensures it will address complaints that weakened user experience. The update looks to bolster consumer and enterprise demand toward its platform that was rattled by competing operating systems such as Google's Android and Apple's iOS.

Lenovo Beats HP

Despite a shrinking PC market, Lenovo managed to outperform the overall PC market for the sixteenth consecutive quarter. The Chinese PC maker claimed top spot as the world's largest PC supplier with 16.7% market share, up from 15% a year ago, on 12.6 million shipments. Predatory pricing and channel expansions have helped Lenovo strengthen market share, revenue, and profits.

<table> <tbody> <tr> <td>PC Vendor</td> <td>Shipments (millions)</td> <td>Market share (%)</td> </tr> <tr> <td>Lenovo</td> <td>12.6</td> <td>16.7%</td> </tr> <tr> <td>Hewlett-Packard</td> <td>12.3</td> <td>16.4%</td> </tr> <tr> <td>Dell</td> <td>9.2</td> <td>12.2%</td> </tr> <tr> <td>Acer Group</td> <td>6.2</td> <td>8.2%</td> </tr> <tr> <td>ASUS</td> <td>4.5</td> <td> <p>6.1%</p> </td> </tr> </tbody> </table>

Source: IDC

Over the years, Lenovo has restructured the company to deploy cost-effective strategies to yield higher profits in its PC and PC Plus divisions. Since 2006, Lenovo improved product delivery performance by 167%, slashed end-to-end costs by more than 50%, increased asset utilization by 10%, and broadened its product ecosystem to meet changing consumer demands.

Yang Yuanqing, Lenovo's Chairman and CEO, told the Wall Street Journal that "more than half of Lenovo's revenue" came from outside of China, an indication of the company's growing global brand recognition. About 10% of Lenovo's revenue came from growth segments such as smartphones and tablet computers.

Hewlett-Packard (NYSE: HPQ) fell to second place with 16.4% market share, up from 15.7%. HP's shipments fell 7.7% to 12.3 million. In an attempt to offset slowing PC sales, the company intends to re-enter the smartphone market. In 2011, HP exited the smartphone business after failing to compete and draw sales from its webOS-based devices. Yam Su Yin, senior director of HP's Asia-Pacific consumer business, responded to reports alleging HP's smartphone revival.

"The answer is yes, but I cannot give a timetable. It would be silly to say no. HP has to be in the game," Mr. Yin said.

Since the arrival of HP CEO, Margaret Whitman, in 2011, the company has undergone a significant cost-restructuring program that aims to recover $3 billion-$3.5 billion in cost savings. HP plans to reduce 10% of its workforce, or about 29,000 employees.

Citigroup believes HP will financially benefit from the cost savings program in the second half of this year, as well as for 2014 and 2015. The bank raised HP shares from a "sell" rating to a "buy" rating, and increased its price target to $32 per share, a price point HP has not traded at since August 2011. Citigroup forecasts HP to earn $3.60 per share this year.

By the end of fiscal 2013, Whitman expects to generate approx. $7.5 billion in free cash flow and bring outstanding debt to zero. In the first half of 2013, HP raked in $5 billion in free cash flow and lowered its debt position by $1.8 billion to $2.9 billion. The company has slashed debt by about $9 billion since the first quarter of 2012.

Bottom Line

China's economic woes have not dampened Lenovo's market dominance. The company improved its cost structure and expansion into worldwide markets such as the United States, where it saw its PC shipments rise 19.7%, despite a 1.9% decline in the overall U.S. market. With Lenovo's new manufacturing facility in North Carolina, expect the company to excel production and gain traction in U.S. PC and PC Plus markets.

HP's stock has continued to outperform the broader market in 2013, up 76.56% year-to-date, compared to S&P 500's 18.31% year-to-date growth. If the company strives to enter the smartphone market again, it needs to learn from its past mistakes and differentiate itself from competitors. Without losing focus in its PC business, HP needs to develop innovative products with new form factors to draw new customers to its devices.

Lenovo and HP present an attractive investment opportunity that may yield long-term growth and profitability for investors.

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