Legend Thinks Out of the Box

Its AOL deal is part of a risky plan to move past low-cost PCs

For Yang Yuanqing it was a sweet moment. On June 11, hundreds of journalists crammed into the ballroom of Kerry Centre Hotel in Beijing, where the CEO of Legend Holdings Ltd. held a press conference with Gerald M. Levin, chairman of AOL Time Warner Inc. (AOL ) The two announced the signing of a $200 million joint venture that could revolutionize China's Internet industry. Yang hopes the deal, 1 1/2 years in the making, will transform Legend from a commodity PC maker to a company that caters to all of China's digital desires. "The needs of our customers have changed," says Yang.

The deal means that every customer who buys a Legend PC gets access to the latest AOL software and many of the services available to the online giant's U.S. subscribers. AOL and Legend will each contribute $100 million to the venture, with Legend owning 51%. For the moment, online services will still be offered through Legend's www.fm365.com Web site. Once China enters the World Trade Organization, Legend owners may see even more of AOL's U.S. menu.

Yang, 36, who assumed the CEO post in April from longtime Chairman Liu Chuanzhi, hopes the alliance will make its inexpensive machines that much more attractive to Chinese consumers. But the tie-up is just part of Yang's much broader strategy to expand and diversify. Not that Legend isn't doing well. The 17-year-old computer maker has a 27% share of the Chinese computer market, according to International Data Corp. The closest rival is IBM (IBM ) at 9%. Analysts predict that profits for the year ended March 31 will jump 83%, to $110 million, on sales of $3.6 billion. Despite the global slump, IDC projects a 28% increase in Chinese computer sales this year. No wonder that Legend's Hong Kong-listed shares are up 23% since Jan. 1.

But when China joins the WTO, foreign rivals will find it much easier to enter Yang's home market. So he has to move beyond production of low-margin PCs. "Legend is one of the most innovative companies in China, but it is still just a computer company," says Charlie Shi, a managing director of China Assets Management Ltd., in Shanghai. "They need to get themselves to the next level."

That means action on all fronts, including computer services, mobile phones, and other new types of hardware. That's pushing Yang beyond the confines of the People's Republic. Last month, during a high-profile trip to Taipei, Yang disclosed that Legend would buy notebook PCs from two Taiwanese contract manufacturers, Mitac and First International Computer, for sale in Europe later this year. Legend already distributes motherboards there, and European notebook sales are growing at a 25% annual clip.

DOWNSIDE. Yang is branching out closer to home, too. In early June, he spun off 50% of Legend's distribution arm, which sells foreign computers and does systems integration, as a separate Hong Kong-listed company called Digital China, raising $48 million for Legend.

There's a downside to Legend's moves, though. It's unclear how much demand there is for more expensive hardware--or even basic PCs--in China. True, the PC penetration rate is 5%, compared with 50% in the U.S., says analyst Johnny Wong of Dresdner Kleinwort Wasserstein in Hong Kong. But "China is not like the U.S., where the average person can afford to buy a PC. In a lot of rural areas, you will probably have zero [penetration] for a long time."

And the European market venture--which Yang downplays as an experiment--is a real flier, since Legend can't rely there on its low-cost production or the support of Beijing cadres who buy its products for their ministries and state-owned companies. "When Legend goes outside of China, it doesn't have the advantage anymore," says Kitty Fok of IDC in Hong Kong. Yang counters that individual consumers now are 44% of its market.

Even the partnership with AOL is no guaranteed success. The three leading Chinese Internet portals, Sohu.com, Sina.com, and Netease.com, have yet to turn a profit and are looking for partners themselves. Give Yang credit for a bold move. Hold the applause, though, until the results are in.

By Bruce Einhorn in Hong Kong, with Alysha Webb in Shanghai

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