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Lenovo’s China Smartphone Profit to Fund Emerging Market Push

Jan. 7 (Bloomberg) -- Lenovo Group Ltd.’s smartphone business in China is about to turn its first profit, enabling the company to expand margins even while funding a handset push in emerging markets, Chief Executive Officer Yang Yuanqing said.

“Very soon you will see we’ll start to make money in the China smartphone area,” Yang said in a Jan. 4 interview at company headquarters in Beijing. “We will improve our profit not just in absolute dollars, but the pretax income ratio as well.”

Lenovo shares surged 36 percent in Hong Kong last year as it added market share to become the world’s biggest vendor of personal computers and China’s second-largest seller of smartphones. Yang is under pressure to maintain profit growth after the costs of that expansion snapped Lenovo’s streak of 12 straight quarters with net income growth of at least 25 percent.

The company’s net income is forecast to gain 24 percent in the year ending March 31, and 22 percent next fiscal year, according to the average of 18 analysts’ estimates compiled by Bloomberg. Those estimates compare with a 73 percent gain last year.

The projection for slowing profit growth is largely because of the company’s expansion of smartphones out of China into markets where it lacks home-field advantage, said Alberto Moel, an analyst at Sanford C Bernstein & Co. in Hong Kong.

India, Indonesia

Lenovo, which introduced its first touch-screen handset in China in 2010, in the past six months expanded sales to Russia, India, Indonesia, Vietnam and the Philippines.

“They are moving into markets where the costs of starting up are higher,” Moel said. “As they grow unit shipments, the fixed costs are growing. They are going to run out of ability to maintain their margins.”

Yang said Lenovo can boost its pretax margins by one percentage point in the next three years, to more than 3 percent, from 2.4 percent recorded in the September quarter.

“You have to invest in new areas but meanwhile you must manage the profit growth as well,” Yang said. “Even though we will further invest in new areas, we are still committed to our shareholders.”

Yang cut his stake in the company last month to 9.04 percent from 9.32 percent, Lenovo said in a filing to the Hong Kong stock exchange.

Outperformed Index

Growth of 13 percent in the three months ended Sept. 30 was the slowest pace since the first quarter of 2010. That may temper further gains in the stock, which last year outperformed the 23 percent advance in Hong Kong’s benchmark Hang Seng Index.

In the next 12 months, Lenovo’s shares are projected to rise to HK$7.76, according to the average of 27 analysts’ estimates compiled by Bloomberg. That would be a 3.4 percent gain from Friday’s closing price of HK$7.50.

“The profit expectations in the stock that are being baked in are for 20-plus percent growth numbers this year and next, and I’m skeptical of that,” Moel said.

He rates the shares market perform and estimates growth in net income will slow from a 23 percent gain this year, to a 14 percent increase next year, hitting $692 million.

Yang maintained profit growth in a stagnant PC industry by expanding market share. The company, which acquired International Business Machines Corp.’s PC unit in 2005, accounted for 15.7 percent of global shipments in the third quarter, overtaking Hewlett-Packard Co.’s 15.5 percent, market- research firm Gartner Inc. said in October.

Smartphone Market

Yang has said he intends to use that dominant position in PCs to expand in mobile devices, including smartphones and tablet computers. Lenovo vaulted to second place in China’s smartphone market in the second quarter from seventh place the previous quarter, market researcher IDC said in August.

“If we cannot improve our existing business like smartphones in China, we will not have the money to invest in new areas like smartphones in other emerging markets,” he said.

Lenovo still has room to boost profitability, according to BOCI Research Ltd. analyst Geng Yang. Net income will gain 25 percent in the next fiscal year ending March 2014 to $800 million, according to the analyst, who rates the shares a buy.

There are 26 analysts with buy ratings on Lenovo shares, compared with eight who rate them a hold or sell, according to data compiled by Bloomberg.

“I believe in Lenovo’s ability in smartphones and PCs,” BOCI’s Yang said. “They are still in a fast growth period.”

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