Rather Be A Gamer Than A Server!

Lenovo, a Beijng-based company, is the world largest personal-computer maker, known for its innovation in x86 server and storage markets. Asustek (ASUS), a Taiwanese company, is the leading gaming PC maker for gamers who want specialized, high-powered rigs.  Both company brands make top quality personal computers.  ASUS’s PCs have been known for their value and long lasting durability while Lenovo’s for their versatility in uses.

Lenovo’s 4Q16 results missed consensus by 13%.  Revenue of $9.13 billion reflected a 29% decline Q on Q, or -19% Y on Y.  But more alarmingly, the smartphone sales dropped 46% Q oQ (-42% YoY), and the PC sales declined by 23% QoQ (-14% YoY).  In contrast, ASUS’s 1Q16 results were slightly better than consensus. Despite lackluster global PC industry growth, ASUS managed to deliver 5% y-y PC revenue growth.  But more significantly, more than half of the growth has been in high-margin gaming/Ultrabook revenues.

Both company’s financials indicted the inescapable long-term trend that the PC industry continues to be negatively affected by structural shifts driven virtualization, commoditization, and cloud growth.  Also, both companies have long attempted to make the strategic shift from the PC industry to the smartphone industry.  Most recently, Lenovo unveiled its first smartphone, Phab2 Pro, based on Google’s Project Tango, following the new Moto Z handsets after its 2014 purchase of Motorla Mobility.  Similarly, ASUS also announced various versions of its ZenFone smartphone, rivaling Microsoft’s MSFT Surface.  Back in July 2015, ASUS launched the 2-in-1 laptop, Chromebook, which was supposed to fill “the sweet spot between a laptop and a tablet.”

However, these efforts may prove be too little too late, for Lenovo at least, to break in the already extremely competitive, over saturated world smartphone space.

Worldwide smartphone sales are predicted to grow only 7 percent to reach a total of 1.5 billion units this year, cooling from 14.4 per cent growth last year and a record-high 73 percent increase in 2010, according to research firm Gartner.  Furthermore, it is estimated that Lenovo reached a peak scale of about $12 billion in smartphone sales and 6.4 percent global market share in the 12 months ended March 31 2015.  There is some evidence that Lenovo has not yet able to gain traction in the smartphone market based on the Motorola brand. The company has been going after the mid- to low-end market but has not had too many successes yet.

In Q116, Lenovo shipped a total of 10.8 million smartphones, down 42 percent from the same period last year, far below an estimation of 15 to 18 million.  Now, there is even a doubt if the two major acquisitions of the IBM server and Motorola smartphone businesses should have been made.  By the way, the storage industry’s move away from networked systems to faster solid-state drives (SSD) does not help, either.

To be fair to Lenovo, there are still some bright spots.  Lenovo is likely to push again into China, US, and APAC, led by India, which has been a growth driver for Lenovo smartphones. China server growth has been quite strong, PC remains a good cash cow, and Lenovo is executing to plan in PCs, with 100-150 basis points of share gains and 5% margins, despite industry and currency headwinds.

Of course, all these depend on that the PC market has to recover.

While ASUS has sustained its PC market share gain for three quarters now, along with the tablet business to ramp down, commercial PC/servers could be the remaining long-term growth drivers.  Since Intel’s new Kaby Lake CPU will not support Windows 7, it will negatively impact corporate PC demand.  ASUS, as one of the leading consumer PC brands, should benefit from the weaker corporate PC plays.  While this is all potentially positive, ASUS’s highly valued Taiwanese talents will execute it effectively to secure its foothold in consumer’s NB space.

ASUS should also sustain its lead in gaming PCs.

Within two years, ASUS is expected to ramp up its smartphone business and add 10% top-line contribution by differentiating market exposure and product strategies.  If successful, the same approach can be replicated in its commercial PC and server businesses, which is less than 10% of current revenue.  Given the less volatile earnings profile of these commercial products, the move into corporate hardware is critical to its long-term sustainability.  As the smartphone business is posited to slow down in 2016-2017, Chinese brands will become more aggressive in ASUS’s growth markets, i.e., Southeast Asia and India.  But, the Taiwanese PC maker should fare better as the traditional PC industry speeds up contracting with consumers increasingly buying lower-cost tablets and smartphones.

Although Lenovo’s stock is at a five-year low and has significantly underperformed ASUS’s stock in recent years, it does not automatically mean a good buy.  Lenovo’s main corporate server business is still more adversely exposed to the sunset PC industry, sluggish global economic growth, and currency headwinds.  In contrast, ASUS’s stock, at a 6x free cash flow level, is likely to remain range bound, given the low price elasticity of gamers’ PCs but lacks a clear earnings catalyst.

Between the two, we rather bet on “gamers” than “servers.”





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