The challenges facing Lenovo in such an important foreign market will be closely followed by investors, given the well-documented difficulties of other Chinese companies in expanding abroad.
Smith, a 22-year IBM veteran, was effectively the CEO of the North and South American operations of Lenovo, ôresponsible for all activities associated with the Lenovo business in the Americas, including all customer sales, marketing, operations, service and support, as well as full income and expense management,ö according to the Lenovo website.
The unit he ran generates almost $4.6 billion in annual revenues for the company.
According to the FY2006 annual report, the Americas contributed 30% to LenovoÆs turnover, compared to 36% from Greater China. 49% of the total turnover came from notebooks, the fastest growing segment, and 45% from desktops.
When Lenovo acquired IBM PCD in April 2005, the former had revenues of $3 billion per year compared to $10 billion for the latter. The deal catapulted Lenovo into the ranks of global vendors, especially on the laptop side, where Lenovo had little presence.
In its traditional mainland Chinese market, the Chinese giant had focused on good-value desktop machines.
ôThe acquisition meant a huge boost to LenovoÆs top line but the size of the deal means that any failure to turn around the PCD will massively affect the group,ö says one observer.
While Lenovo is phenomenally successful in China and increasingly India, performance has lagged that of Dell and HP in the US.
The PCD is perceived as having left a legacy of high costs by Lenovo, some of whose executives have privately commented on the need for a greater performance-based culture at the PCD.
Manish Nigam, a leading technology analyst for Credit Suisse in Hong Kong, says that the key for Lenovo is to translate solid gross margins at the division into the bottom line.
ôItÆs clear the PCD faces a bottom line problem. Expenses and charges are eating into the top line cash before it reaches the bottom line,ö he says.
On the back of the IBM PCD acquisition, Lenovo announced turnover of HK$104 billion ($13 billion) for FY2006, compared to HK$23 billion in 2005. However, the expense to revenue ratio went up to 13.1% from 8.8% for the period, and profits attributable to shareholders dropped almost 90%, from HK$1.12 billion to HK$173 million y-on-y. Excluding the restructuring costs, the company estimates pre-tax profits increased 7% on-year.
Many observers agree the æhigh cost, high qualityÆ culture of the former IBM PCD is unsuited to an increasingly commoditized product.
One of the first major management changes at the PCD after its acquisition by Lenovo was the replacement of the IBM PCD CEO Stephen Ward with Bill Amelio, the Asia head for Dell. Dell is considered to have an industry-leading ability to cut costs and manage its supply chain.
The US market is a tough market for Lenovo to crack. IBM PCD used to focus on the Fortune 500 enterprise market for sales of its prestigious, expensive laptops. However, this is the slowest growing segment of the market.
Paradoxically, the Lenovo brand (as opposed to IBM) is doing very well in the US amongst small and medium enterprises, who are grateful for an alternative to Hewlett-Packard and Dell.
In effect, says one industry source in Hong Kong who preferred not to be named, the performance of Lenovo in the US raises the question of why Lenovo had to buy IBM in the first place.
ôItÆs always interesting to look at deals in retrospect and see which side was more savvy. Lenovo were feeling vulnerable in their home market in 2004, which is why they wanted to hook up with IBM to get some international muscle. But in fact, they have come roaring back in China after adapting to the challenge of foreign competition. And the Lenovo brand is doing remarkably well among the SME sector in the US,ö he says.
The analyst also points out that relatively few synergies will have come from combining back office operations û since PCD was only a division, it didnÆt have any back office functions to lose. Lenovo paid $1.75 billion for the PCD, including assuming debt worth $500 million.
One private equity specialist says that at the time (2003-2005) the number of Chinese companies investing in foreign assets was at its peak - but that the result of deals struck then, including TCL merging with France's Thomson), has seemingly not encouraged a continuation of the trend.
"When Hong Kong-based Techtronics Industries bought Hoover in December 2006, also an iconic brand, the price was a bargain basement $107 million," she says.
ôThe key point is whether the current drag on profits is due to one-off restructuring charges, or whether there is a systemic problem with excessive costs in LenovoÆs US operations. Everybody will be watching the latest results,ö says one analyst.
Apart from the intriguing possibility of selling off the unprofitable part of the US operations to a cash-heavy private equity firm, itÆs not clear how Lenovo can improve the situation, say industry sources.
PC manufacturers usually achieve profitability through scale, which is associated with market share. But the high-end market share for PCs seems to be dying out, with many of the fanciest functions being replicated by mobile phones and personal organizers.
Massive staff cuts would also be a possibility, since staff are the biggest component of fixed costs in the industry, say analysts.
But whatever the woes brought by the PCD to Lenovo, the publicity generated by the deal was priceless, say the optimists. In addition, IBMÆs prowess in laptops will surely help Lenovo continue its dizzy growth in developing markets.
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