UPDATE 2-For Lenovo, ThinkPad turnaround provides blueprint for Motorola handset future

Thu Feb 13, 2014 5:38am EST

* Q3 net profit $265.3 mln, up 29 pct from year earlier

* Acquisitions to weigh on earnings in short term -CEO

* Profit recovery after 2005 ThinkPad buy took two years

By Paul Carsten

BEIJING, Feb 13 (Reuters) - Lenovo Group Ltd leader Yang Yuanqing says the Chinese technology giant will draw on cost-cutting lessons learned when it bought IBM Corp's ThinkPad laptop unit to turn losses into profit at businesses acquired for $5.2 billion last month.

Reporting third-quarter profit jumped 29 percent, Lenovo's chief executive warned the drive to turn around the Motorola handset business it bought from Google Inc and the computer server unit it bought from IBM will squeeze earnings in the short term.

For Yang, the pain may only last "a couple of quarters" after the deals close, he said, and is worth it: though October-December personal computer sales were strong, the aggressive acquisitions are a key plank in Lenovo's search for future sources of growth as the broader desktop PC market shrinks and computer users go mobile.

"In the short term (the deals) will have a negative impact on performance," Yang said in a telephone interview after the earnings were announced. Lenovo, the world's biggest maker of PCs, later specified it will likely take three to five quarters to turn around the Motorola phone business.

Analysts say it may take the company at least that long to turn around its acquisitions. Heavyweights like Samsung Electronics Co and Apple Inc, dominant in global smartphones, will also provide stiff competition as Lenovo seeks to build up the Motorola business.

"I'm expecting a slowdown in the underlying, organic business," said Jean-Louis Lafayeedney, a Hong Kong-based technology analyst at JI Asia, an affiliate of Societe Generale. "It will be at least a year before Lenovo can turn around growth," he said, speaking before Yang's comments.

DEJA VU

Investors might be experiencing déjà vu. Motorola Mobility and the IBM x86 server unit currently lose money - Motorola alone lost more than $1 billion in 2013 - just as ThinkPad did when it became the Chinese company's way into businesses across the United States in 2005.

After the ThinkPad deal, Lenovo's net income dropped sharply and only recovered after almost two years.

To bring the new acquisitions into the fold, Lenovo plans to revive its tactic of integrating ThinkPad through cost-cutting, lower material costs and merging the business with its own supply chain.

Lenovo will sell Motorola handsets and IBM servers through the same channels it uses for its own low-margin smartphones and its PC business, Yang said in a post-earnings call, without elaborating on financial targets.

Lenovo said it plans to re-introduce the Motorola brand to its home country - a smartphone market now beginning to become saturated - as well as expanding to emerging markets. A key part of its strategy for IBM's low-end servers is to surf on Lenovo's presence in China, where it said server demand remains strong.

But the sheer size of these deals - the price tag is close to half of Lenovo's market value - will weigh on the company for some time. Analysts don't expect the deals to be finalised until the third quarter of 2014 at the very earliest.

"They did not have a choice, they had to acquire a business to take their smartphones to the developed markets," said Lafayeedney. "They cannot waste the kind of time needed to grow organically into developed markets," the analyst said, speaking before the October-December earnings were announced.

AHEAD OF ESTIMATES

Lenovo on Thursday reported net income of $265.3 million for the October-December quarter, ended before the acquisitions splurge. That was well above the $204.9 million it posted a year earlier, as well as a $247.2 million consensus forecast on Thomson Reuters Starmine SmartEstimate.

Although Lenovo is the world's fourth-biggest manufacturer of smartphones by shipments as of the quarter ended December, according to data firm IDC, the company is still dependent on China for the vast majority of its sales.

Of the 13.9 million handsets Lenovo shipped in that quarter according to IDC, Lenovo said on Thursday only 2 million, or 14 percent, of those were sold outside China.

Yang told analysts in a conference call the smartphone unit does not yet contribute a lot to the overall profit of Lenovo, particularly in China, where margins are slimmer than in other markets. Overall China smartphone shipments fell for the first time in more than two years in the quarter ended December, declining 4.3 percent quarter-on-quarter to 90.8 million handsets, according to IDC.

The speed and scale of the buying spree - partly paid for by issuing new shares - spooked some investors. Earlier this month Lenovo shares tumbled 16 percent in one day after a report said the company was interested in buying Sony Corp's Vaio PC division.

Lenovo shares have dropped 8.7 percent since the start of the year, compared with the Hong Kong index's loss of 4.82 percent. By close of trading on Thursday, the stock was down 0.58 percent, while the index was off 0.54 percent.