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Things Are Looking Lovelier for Lenovo

It has been a wild year for Lenovo (LNVGF), the Chinese computer maker that last year made a splash by taking over IBM's PC division (IBM). The acquisition made Lenovo a global leader among Chinese companies and catapulted China's No.1 computer brand into contention for the top spot among global PC makers, trailing only Dell (DELL) and Hewlett Packard (HPQ).

But digesting the former IBM unit hasn't been easy. After only a few months with an IBMer at the helm, the company brought in a new chief executive, William Amelio, from Dell. He came in focused on cutting costs and repositioning Lenovo to compete against his old company. Even as Lenovo had to contend with aggressive price cuts from Dell, Amelio and his team had to look over their shoulders at Acer, the Taiwanese company that is No.4 in the global ranks and eager to dislodge its Chinese rival.

Lenovo also lost market share in the U.S. and other non-Chinese markets. Even before the Lenovo takeover, the IBM business had been struggling, and the transition seemed to accelerate the slide. Investors weren't happy: Lenovo's Hong Kong-listed shares dropped 40% from December to June. "There was talk that Lenovo was experiencing serious buyer's remorse," says Martin Kariithi, an analyst with Technology Business Research, a market watcher based in New Hampshire.

STREAMLINING. Then on Aug. 3, Lenovo announced its second-quarter results, which appear to show that the heartburn from IBM is abating. Lenovo reported sales were up 11%, to $3.46 billion. Net profit was $5 million—not great, but more than double the previous quarter. Restructuring costs were lower than expected, and Lenovo is regaining market share in the U.S., China, and elsewhere. The company's stock price jumped 3.6% in Thursday trading in Hong Kong following the announcement, a reflection of the good feeling many now have about the company.

What's behind the turnaround? For starters, Amelio has lowered costs by eliminating 5% of Lenovo's workforce, or some 1,000 positions. More important, that's 10% of the company's non-China workforce, says Ho, a sign that Lenovo is dumping high-cost employees it inherited from IBM and instead focusing on lower-cost China.

All of those job cuts hurt the bottom line in the short term, with Lenovo reporting $147 million in restructuring costs for the quarter. But in an Aug. 4 report, Deutsche Bank analyst William Bao Bean writes that the number is better than what he had expected. According to Bean, "Lenovo is on the right track."

PRODUCT MIX. Another good sign for Lenovo is that it's starting to see the results of a move to diversify its U.S. lineup. Early this year, the company launched a new range of PCs, using the Lenovo name rather than IBM's Think brand, targeted at small- and mid-sized businesses in the U.S., a market IBM had largely ignored.

To better reach that segment, Lenovo has expanded sales to big box retailers such as Best Buy (BBY) and Office Depot (ODP). That has helped Lenovo reverse its slide in U.S. market share, moving from 3.9% in the first quarter to 4.2% in the second. The product mix is improving, too, with growing sales of more profitable notebooks leading to gross margins of 14.3%, up from 14% in the previous quarter.

There's still a long way to go. Even with the rebound in market share, Lenovo faces a rough road in the U.S., where rivals are fighting hard for old IBM customers who might have reservations about switching to a PC maker from China. And Lenovo is particularly vulnerable to a Dell-inspired price war, says Kirk Yang, a managing director with Citigroup in Hong Kong.

MATCHING PRICE CUTS. Dell is slashing prices by as much as 22%, with buyers saving an average of $100 per machine. Lenovo's U.S. customer base is similar to Dell's (both are strong with corporations and consumers) while HP and Acer focus more on small- and mid-size businesses.

So "Lenovo has to match Dell's price cuts," says Yang, who says he's uncertain whether the Chinese company will be able to make the old IBM unit a success. "So far, Lenovo management hasn't shown that they can consistently make money from the business, particularly in the U.S."

LOOKING UP. To compensate, Lenovo is probably going to be pushing even harder in its Asian backyard. The company is well-positioned to use its experience in China to grow in the other emerging giant, India, says Joseph Ho, an analyst with Daiwa Institute of Research in Hong Kong. "Lenovo is going to hit the Indian market," he predicts.

Lenovo's sales there are still tiny, but that will change, he says, adding that Lenovo has an advantage over Dell, because Indians are not used to buying PCs online. When people aren't accustomed to e-commerce, "the Dell online purchasing model doesn't work," he says. "India is a big positive for Lenovo." That's down the road, though. For now, the key markets are China and the U.S. And after a year of difficulty, they're starting to look better for Lenovo.

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