China PC Maker Lenovo's Quarter Nearly Triples

Lenovo, battling Acer for the mantle of world's No. 3 PC maker, smashed expectations with a near-tripling in quarterly earnings thanks to robust PC demand and market share gains.

Though the fiscal second quarter marked its second-best quarterly performance since buying IBM's troubled PC arm in 2005 for $1.25 billion, analysts fear rivalry with Acer, Hewlett Packard and Dell and a push into a cut-throat consumer arena in 2008 will hold margins back.

Still, analysts expect earnings to be underpinned by expanding sales volumes, especially in Europe, and as corporate-focused Lenovo rides a global PC replacement cycle.

"The story remains the same -- market share gains and margin expansion," Citigroup analyst Kirk Yang said. "Lenovo's transactional model and new consumer focus allow it to enter a previously untapped market, while it has benefited from exposure in the emerging market with higher growth."

Lenovo's gross margins inched higher to 15.1 percent in the quarter from 13 percent a year earlier, propped up by a sharp improvement in Europe, the Middle East and Africa, which executives attributed to cost control and a strengthening euro.

In 2008, the firm hopes to roll out new PCs to try and capture more of the consumer space, but also business-oriented workstations and servers to buoy margins.

Lenovo, China's top computer maker, earned a net profit of $105.26 million in its fiscal second quarter ended September, compared with $37.89 million a year earlier.

That trumped an average forecast for US$88 million, according to five analysts polled by Reuters Estimates.

And it handily outpaced Acer's 58 percent earnings growth over the same period. The Taiwanese PC giant said it expected to control 11-12 percent of the global market in 2008, after having absorbed U.S. vendor Gateway last month.

"We're in the middle of a replacement cycle," Chief Executive William Amelio told analysts on a conference call. "That's why you see a firming up of demand."

A Global Footprint

Investors will wait to see if Lenovo's consumer push globally -- anchored by its dominant market position back home, the world's second-largest PC arena -- will depress margins.

Lenovo -- one of a handful of Chinese firms trying to forge a global brand -- retained its No. 3 perch with 8.2 percent of worldwide shipments in the calendar third quarter, while Acer followed with an 8.1 percent market share, according to IDC.

But Acer may have leap-frogged Lenovo after it bought Gateway for $710 million. As part of the acquisition deal, Acer pledged to fund Gateway's intended purchase of Paris-based Packard Bell -- which Lenovo had been hoping to buy to expand its European operation.

Analysts saw few viable targets left for Lenovo now.

"The industry is consolidating and we're interested in any possibilities out there -- at the right price," Amelio said.

Lenovo's shares jumped nearly 30 percent from July to September, outperforming a 25 percent rally on the benchmark Hang Seng Index. On Wednesday, they soared as much as 11 percent to a seven-year high as investors bet on rosy earnings.

On Thursday, they slid 2 percent as investors cashed out.

Lenovo trades at 32 times forecast earnings, pricier than Acer's 14, HP's 18 and Dell's 21, according to Reuters Estimates.

"This was a strong quarter for Lenovo. The gross margins are surprisingly good. The second quarter is typically weak but Lenovo did even better than the last quarter," said JP Morgan's Charles Guo.