Lenovo: Issues to consider

Lenovo (992 HK): Issues to consider

Update: Lenovo Q3 2020 results ++

Revenue is flat Q3 on Q3
Data centres are flat Q3 on Q3
China revenue is down
Most growth appears to have come form the FCCL acquistion

New issues to consider:

Q4 Revenue, profit cashflow will probably suffer due to virus
Payables are rising to offset rising receivables
Inventory days are flat even though supplier balances are down

Update: Lenovo 1H 2020 results

Receivables are rising faster than revenue
Bad debt provisions are down in both absolute and relative terms
Factoring has spiked
Lenovo is still borrowing to fund dividends

New issues to consider:

Beware possible channel stuffing and ever-greening
Legend (3396 HK) the parent's interest cover is now below 1.6x
Data centres and the Netapp JV are not delivering
Sub-contractor working capital is an issue

Update: Lenovo 1H 2018 results

Revenue is up overall but falling in China.
Lenovo is only profitable thanks to a tax credit and only operating cashflow positive as a result of paying its staff with shares.
The company is bleeding at an annualised rate of US$800m. The US$500m injection from the parent will not last forever.
We have to believe the dividend will be cut, sooner rather than later

New issues to consider:

Factoring costs are rising again - more working capital being moved off balance sheet
Defferred tax is up i.e. estimated profits are rising
Other receivables/payables, suppliers warehousing US$1bn of inventory
Inventory up 28% for sales up 2%

Update: Lenovo Q1 2018 results

They are manipulating working capital to try and disguise the cash burn
Factoring costs, receivables and payables are up
Inventory is becoming a problem

Update: Lenovo FY 2016/17 results

Nearly all profits are coming from one off gains
Excluding changes to working capital, Lenovo is only generating US$52m from revenues in excess of US$40bn. Capex is much higher than this
The jump in net-cash from operations, US$0.3bn to US$2.1bn, is the result of squeezing working capital

Background

Lenovo moved into the big time with the purchase and successful operation of IBM’s Thinkpad business. Since then their acquisitions have yet to show a similar level of success. At the last results announcement, the company reported a net cash position and talked optimistically about its progress. The recent debt raising, to pay off Google, was a success suggesting that its lenders have been persuaded that the company is turning around. However, having reviewed Lenovo’s accounts, we believe that there are some intriguing issues that Lenovo’s current level of disclosure does little to clarify. We tried to contact IR about these issues but received no response.

Issues to consider

Leverage

Does Lenovo expect to pay Compal US$220m or US$750m. How should investors assess the success/failure of this joint venture?
What is the outstanding receivables balance and what interest rate or fees does the company pay for this service to boost its cash balances?
How much have the fluctuations in cash and debt balances been due to changes in factored balances?
Lenovo’s interest costs seem quite high for a company with a small amount of short-term loans, why is this? Could it be that Lenovo’s average daily debt balance is a lot higher than at accounting dates?

Revenue profitability and cashflow

Lenovo has remarkably large payable and receivable balances with its subcontractors. This suggests they account for a significant proportion of Lenovo’s revenues. What percentage of revenues come from these sales? Why does Lenovo not just pay a fee to subcontractors for work done. How much inventory do subcontractors hold on Lenovo's behalf?
Despite talk of a turnaround, and making substantial provisions, operating margins have continued to fall. What percentage of the US$1bn + cost cuts previously announced have already been made? Are there any signs that margins are stabilising or improving?
Lenovo’s cashflow is presented after changes to working capital but no mention is made of the changes to factored receivables. Will management consider changing the presentation so that investor can get a better understanding of cash flow?
Pay for senior management has risen dramatically, while sales and profits have declined, why is there such a disparity?
We note that audit fees are quite low for a business of Lenovo’s size and business mix. How much confidence can investors have in the quality of the audit and the accounts?

Balance sheet

There haven’t been any impairments to goodwill despite the purchased businesses performing worse than even the expectations disclosed in FY2016 annual report. Could management please reveal the assumptions behind their original acquisitions and those used today?
Lenovo funds its Chinese pension schemes and awards management large bonuses but so far has made only minimal contribution to its overseas liabilities. These pension obligations are now multiples of their assets and the pensioners. Does the company intend to honour its pension obligations to its non-Chinese workforce?

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Important
This note is written with the sole purpose of highlighting some issues we think are important.
It is not a recommendation to BUY or SELL any of the securities mentioned and should not be taken as such.
Readers should form their own opinions about the company and seek appropriate advice.
Please read the Bucephalus disclaimer.