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Another Perspective


THINKING ABOUT THINKSTUFF

If you are like most business computer users, it's been a long time since your go-to gadget was a ThinkPad.  But outside the declining post-industrial economics, Lenovo's client computers are market leaders.  This year, with Hewlett-Packard and Dell slipping, Lenovo's third world first strategy could bring it to first place on a global basis.  The company's next conquests might be in the server business.  You don't think so? Well, EMC does.  Soon, your servers might say Lenovo instead of IBM, if not on their outside name tags, very possibly on the inside ones that count.

IDC data
IDC's Optimistic Future
The PC business will rebound, says IDC, powered and transformed
by emerging economies rather than the post-industrial states,
which are in a slump

Unusually, the people who first seem to be noticing that a revolution is underway are the people who manage institutional investments.  The last time this happened in a big way was around 1980 when the Apple II had taken off, the Visicalc spreadsheet program caught the flickering imagination of the financial community, and IBM was working on the original PC.  What seems to have caught the attention of Wall Street, however, is not so much the phenomenal progress made by Lenovo but the train wreck that used to be HP and the Texas-size troubles of Dell.  Only after losing their shirt are the shareholders of HP and Dell coming around to spotting new winners in a client computer business that, contrary to so many headlines, isn't terminal but is suffering a nasty bout of financial flu.

The result is a new computing world order, and, if trends during the first half of this year continue through the remainder of 2012, Lenovo will get PC market blue ribbons from IDC and Gartner, HP will be in second place by just a smidgen, while Taiwan's Acer could ace out Dell for third place, although forecasting a really lousy year rather than just a difficult one for Dell is probably foolhardy.  No, Dell's faithful will probably have to wait until next year to experience fourth place, by which time Acer could well have been acquired by its Taiwanese neighbor, Asustek, which has superior technology and, currently, superior business management, too.

While all this turmoil afflicts the desktop and laptop PC trade, developments of equal importance are underway in the server segment.  Lenovo has made ThinkServer brand machines for a while, but they aren't all that abundant in American offices and only slightly more visible across Europe.  HP and Dell have much larger images and, despite the miserable time they are having right now, vast resources and terrific staying power.  Still, Lenovo has managed a coup: As Dell's storage business has grown up and away from the partnership with EMC that had been its foundation, EMC determined that it would be better off with servers made by a company that was not a rival--not yet, anyway.  In the near future, which means during 2013, EMC's storage subsystems will feature X86 (and for all we know ARM) computers developed within a collaborative effort of EMC and Lenovo.

My personal view is that this relationship could be a brief love affair, not because Lenovo would, like Dell, want its own storage products, but because EMC's lawyers, professionally jealous by definition, would want their client to control the intellectual property that, far more than drive electronics, makes storage, done right, so vastly profitable.  For now, EMC really couldn't become an independent force in X86 servers.  Far too much engineering knowhow and an awful lot of patent control have long since been held by the top PC manufacturers.  Lenovo got its first whopping IP (meaning intellectual property here, not Internet protocol) portfolio from IBM, which was and is great at the business of monetized ideas.

To make its own controllers and have a good chance for these machines to be great, which they would have to be, EMC would have to buy, barter for or build a lot of server technology of its own.  That might happen in a young part of the server business, where ARM (and MIPS) technology lives, but it's unlikely to occur in the mature and over-lawyered X86 universe.

The only exceptional route that might be open to EMC could arise if it obtained control of Advanced Micro Devices, recouped much of its initial cost via deals with VMware and others, and conjured up some kind of X86 manufacturing deal with a great partner now on the sidelines.  A conglomerate like the Tata Group might be a good fit, but a hungry electronics outfit like HTC would not.  It would not be impossible for imaginative and capable EMC to execute far better than Oracle and its embarrassment-prone server guy, Mark "Not Naked Lunch" Hurd.

In the meantime, Lenovo is scrambling to deflect criticism that arises because it is a Chinese company.  Part of its plan is to set up computer manufacturing in the United States.  The upshot could be a line of business computers that are as Made In USA as anything HP sells (and probably more so than Dell's PC products).  Lenovo has had a US headquarters in Morrisville, North Carolina, dating from its acquisition of IBM's personal computer business.  I doubt Lenovo will make laptops in the USA since nobody else does, but it could leap into tablets or other devices via an American facility the way it has learned to exploit Japanese design, engineering, and manufacturing prowess via its joint venture with NEC.

As Lenovo's American profile increases in size and visibility, business users are bound to notice just how well the company seems to be doing, particularly in comparison to its competitors and especially when contrasted with last year's leader, HP.  HP's current boss, Meg Whitman, seems to have the confidence of the company's directors as she steers her company through a fiscal therapy that will, in the near term, include more pruning than planting.

Income Statement 2012 2011 Change
Sales $8,010.0 M $5,920.0 M 35.00%
Gross profit $959.0 M $739.0 M 30.00%
Gross profit margin(%) $12.0 M $12.5 M -0.50
Operating expenses -$777.0 M -$616.0 M 26.00%
Expense-to-revenue ratio (%) $9.7 M $10.4 M -0.70
EBITDA $250.0 M $177.0 M 41.00%
Pre-tax income $185.0 M $123.0 M 50.00%
Pre-tax income margin (%) $2.3 M $2.1 M 0.20%
Profit attributable to equity holders $141.0 M $108.0 M 30.00%
EPS - Basic (US cent) $1.4 M $1.1 M 26.00%
EPS - Diluted (US cent) $1.3 M $1.1 M 25.00%
Lenovo Financials
On the rise, at least for the quarter ended Jun 30

If Lenovo wants to get to the top in computing and stay there it has to move boldly and wisely while HP is in recovery and Dell is off its game.  That probably means moving far and fast in servers, including serious contemplation if not real action outside the X86 space.  That expansion could involve ARM architecture.  It could also include a careful migration into Power country, if Lenovo could persuade IBM to share its chips.

As Sun's Sparc sets and the Itanic sinks beneath the waves of history, Power seems to have become the last big engine technology still standing.  Lenovo might be the only computer manufacturer willing to play by IBM's rules in return for a chance to get into the Power market.  IBM would have to change its behavior quite a bit if it turned over all its hardware manufacturing to a subcontractor, but the folk in Armonk know full well how well Apple has done by developing appropriate relationships with hardware manufacturers.  As long as Power customers could get their AIX and IBM i software, service, and support from Big Blue, it is doubtful that they would care much of their servers were Lenovo inside.  IBM seems to have done well making only the hardware it absolutely has to, and it also seems to have a pretty good record deciding what hardware to make (not much these days) and what to buy (plenty).

It could even turn out that IBM's mainframe manufacturing goes up for grabs.  In the past, IBM remarketed mainframe made by Hitachi.  Sales went fine.  The machines enjoyed as good a reputation as any made entirely by IBM and, in the fullness of time, carried residual values that were the absolute equal of the values provided by pure IBM machines.  Hitachi also rebrands and resellers IBM's Power Systems machines in Japan to supercomputer customers, as Bull does as well in France.

In addition to its history, size, and success, Lenovo has an advantage as a potential server supplier that other computer makers don't enjoy: Lenovo has managed to avoid competing head-to-head with IBM.  That distinguishes it from HP and Dell, from Fujitsu and Hitachi, from Oracle and EMC, and from any other company you can think of that has the resources to become a real partner of Big Blue.

What unfolds here--or fails to unfold--has to happen soon.  Yes, the PC business is in a slump, at least in the leading economies, but it is not the end of the industry.  When conditions improve, which could take another year or two or three, historians of business might find it interesting to compare and contrast computing during the Great Recession with automobiles during the Great Depression.  The Depression took a tremendous toll of car makers, but a generation later the motor business in aggregate boomed.  There is no way to say whether today's computer makers will all be in business (or in the computer hardware business) a few years from now, and that cohort includes IBM (which might be better off quitting hardware).  But there will be a computer business and a smartphone business and by the end of this decade they might or might not be one and the same.

Still, whatever transpires, whichever enterprises become the next generation of leaders, we are pretty confident that one bunch of successful products will be called Think.

— Hesh Wiener October 2012


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