Lenovo Group Limited Overweightpg.jrj.com.cn/acc/Res/HK_RES/STOCK/2014/2/3/d55e20...Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Price Performance 0992.HK share price (HK$) MSCI-Cnx (rebased)

www.jpmorganmarkets.com

Asia Pacific Equity Research03 February 2014

Lenovo Group LimitedOverweight0992.HK, 992 HK

“Hello Moto”: Tricky execution, but Right Direction; Keeping the Faith

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Price: HK$10.06

Price Target: HK$10.70Previous: HK$12.50

China

Technology

Gokul Hariharan AC

(852) 2800-8564

[email protected]

Bloomberg JPMA HARIHARAN <GO>

Alvin Kwock

(852) 2800-8533

[email protected]

J.P. Morgan Securities (Asia Pacific) Limited

YTD 1m 3m 12mAbs 6.0% 7.6% 23.0% 21.2%Rel 12.4% 13.8% 28.4% 31.3%

Bloomberg 992 HK, Reuters 0992.HK(Year-end Mar, $ mn) FY13 FY14E FY15E FY16E FY13 FY14E FY15E FY16E Target Price (HK$) 10.7

Sales 33,873 38,659 45,221 57,834 P/E 21.0 16.9 15.7 13.3 Price Target End Date 30-Mar-15Operating Profit 800 1,039 1,155 1,441 P/BV (x) 5.6 4.6 3.8 3.0 Share Outstanding 10,137mnEBITDA 990 1,279 1,475 1,761 ROE(%) 27.5 33.0 29.6 29.7 Free float -

Pretax Profit 801 1,019 1,134 1,365 Cash Div ($) 0.03 0.03 0.03 0.03 Avg daily volume 40.86mn

Adj. Net Profit 635 798 874 1,082 Quarterly EPS ($) 1Q 2Q 3Q 4Q Avg daily val (USD) 50.0mn

EPS ($) 0.06 0.08 0.08 0.10 EPS (13) 0.01 0.01 0.00 0.00 Dividend Yield (FY2014) 2.5%Net Debt (2,885) (2,871) 42 (504) EPS (14) E 0.01 0.02 0.02 0.02 Index (HSI) 6019.07

Y/E BPS ($) 0.23 0.28 0.35 0.43 EPS (15) E 0.02 0.03 0.03 0.01 Market Cap(USD) 13,134mn

Source: Company data, Bloomberg, J. P. Morgan estimates.

See page 11 for analyst certification and important disclosures, including non-US analyst disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

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Jan-13 Apr-13 Jul-13 Oct-13 Jan-14

Price Performance

0992.HK share price (HK$)

MSCI-Cnx (rebased)

We believe Lenovo is moving in the right direction with the Motorola deal and remain OW, but lower our Mar-15 PT to HK$10.7 (14x FY16E EPS) and cut FY16E EPS by 13%. While mindful of the execution risk (especially in the US where Apple/Samsung dominate) and the challenging task of turning around Moto's losses, we believe this is the right step in establishing a global Smartphone presence through patents, carrier relationship and expanding footprint in non-China EMs. In the near term, we believe the stock would be choppy until a baseline is established for Motorola's ongoing losses, but the IBM server profits should offer some buffer. Key upside driver will be clarity on Lenovo’s turnaround plan to mitigate losses, while Amazon launching a Smartphone in USwould be a key tail risk.

Deal right move for Lenovo, stock could be choppy near-term: We believe Lenovo needed an established patent portfolio, carrier relationships and a brand with good recall to move up and establish a global presence and move away from the chasing pack of Asian brands. While consolidating m/s from smaller brands like HTC should be easy, going up against Apple and Samsung will be a challenge, especially in US. Potential licensing deals with IP licensing vendors like Nokia (once it exits handsets) could be a low-risk option, but cumulative IP royalty payments could be sizeable, making it a low-return move, in our view.

Moto turnaround to take time, but share gains should come through quickly: On a recurring basis, Motorola is running at ~25% EBIT losses, making the turnaround task a challenging one. We firmly believe that Lenovo should be able to leverage the Moto brand in EM/Latam to gain share and also enter new markets. However, the US market share face-off with Samsung/Apple would be tough. Factoring in strong operating leverage, Lenovo may need to double Motorola sales to get the business close to breakeven levels (see our Proforma analysis on page 5). We factor in Motorola still losing ~$280M in FY16 in our current estimates, although establishing baseline profitability for Motorola is difficult due to the extent of restructuring undertaken by Google.

Impeccable M&A track record vs. a rarity of comebacks in mobile: Lenovo’s M&A track record in mature segments has been impeccable but comeback stories (except Apple) are also very rare in mobile. We expect Moto’s patents and carrier relationships would be invaluable to Lenovo, and remain confident of Lenovo’s ability to use Motorola in different emerging markets, but a Moto-led comeback in US could be difficult and costly.

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Gokul Hariharan(852) [email protected]

Key catalysts for the stock price: Upside risk to our view: Downside risks to our view:

• Improving PC dynamics• Enhancing smartphone ASP and margin • Integration of IBM on x86 server business

• Faster-than-expected progress of IBM x86 deal closure

• Slower growth in non-China market• Execution issues in tablet rollout• Integration risk for Motorola deal

Key financial metrics FY12A FY13A FY14E FY15E Valuation and price target basis

Revenues (LC) 29,574 33,873 38,659 45,221 Our Mar-15 PT of HK$10.7 is based on 14x one year forward earnings. We expect some volatility in share price in the near term, while Lenovo's wellproven M&A track record and its leading PC position keep us OW.Revenue growth (%) 37.0% 14.5% 14.1% 17.0%

EBITDA (LC) 934 990 1,279 1,475

EBITDA margin (%) 3.2% 2.9% 3.3% 3.3%

Tax rate (%) 18.4% 21.2% 21.2% 20.3%

Net profit (LC) 473 635 798 874

EPS (LC) 0.05 0.06 0.08 0.08

EPS growth (%) 65.1% 32.0% 24.6% 7.6% P/E band chart

DPS (LC) 0.02 0.03 0.03 0.03

BVPS (LC) 0.26 0.23 0.28 0.35

Operating cash flow (LC mn) 460 -219 1,420 1,256

Free cash flow (LC mn) 30 -602 1,435 1,273

Interest cover (X) 1,182 -471 42 68

Net margin (%) 1.6% 1.9% 2.1% 1.9%

Sales/assets (X) 2.2 2.1 2.2 2.2

Debt/equity (%) 15.2% 26.2% 31.7% 62.8%

Net debt/equity (%) -138.3% -133.0% -107.9% 1.3%

ROE (%) 22.1% 27.5% 33.0% 29.6%

Key model assumptions FY12A FY13A FY14E FY15E

NB shipment (M) 27.8 30.7 33.0 37.5

Smartphone shipment (M) 6.2 28.6 49.3 62.8

Tablet shipment (M) 0.9 2.4 9.8 13.1

Source: Company, J.P. Morgan estimates. Source: Bloomberg, J.P. Morgan.

JPMe vs. consensus, change in estimates

EPS FY14E FY15E

JPMe old 0.076 0.088

JPMe new 0.077 0.083

% chg 1.1% -6.6%

Consensus 0.077 0.091

Source: Bloomberg, J.P. Morgan estimates.

Comparative metrics Ticker Rating Price CMP Mkt Cap P/E P/B

Target LC $M FY14E FY15E FY14E FY15E

Lenovo 992 HK OW 11.7 10.1 14,066 16.9 15.7 4.6 3.8

Pegatron 4938 TT UW 33.0 39.9 3,048 11.0 10.8 0.8 0.7

Quanta 2382 TT N 67.0 75.0 9,528 13.5 11.5 2.1 2.0

Compal 2324 TT OW 25.0 22.8 3,309 11.0 9.0 0.9 0.8

Wistron 3231 TT N 25.0 25.1 1,967 10.6 9.7 0.9 0.8

Acer 2353 TT UW 13.0 18.0 1,677 26.3 29.9 0.8 0.8

Asus 2357 TT N 220.0 282.0 6,904 11.9 12.4 1.5 1.4

HonHai 2317 TT OW 87.0 84.9 36,740 9.7 9.5 1.2 1.1

Source: Bloomberg, Company and J.P. Morgan estimates.

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LENOVO GROUP 8x 12x 16x 20x

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Lenovo buying Motorola – A necessary, but expensive deal to step up in Global Smartphone space

We believe that buying Motorola was an essential deal to step into the global Smartphone market, with access to a significant patent portfolio, cross licensing agreements with other brands and carrier relationships, this positions Lenovo to leapfrog the chasing pack of Asian brands and positions it as a clear No 3 in the Smartphone space. We also believe that Motorola has enough brand recall to help Lenovo gain share in emerging markets outside of China.

The strategic relationship with Google (OW, covered by Doug Anmuth), which would own 5% of Lenovo post the deal closure, should also position Lenovo as a significant player within the Android ecosystem and adequate IP coverage as it expand its Android product offerings outside of China.

However, the one tough market, in our view, would be the US, where Lenovo aspires to make market share inroads using the Motorola brand.

Other options equally risky, licensing could have been low risk but low return

While considering other available options like Blackberry and HTC, we believe that Lenovo has settled for the best available choice (in terms of depth of IP portfolio and brand recall), but all these options do involve a tricky turnaround in mobile revenues and profitability.

A lower-risk option in our view, would have been to enter into potential IP licensing agreements with vendors like Nokia (post the sale of handset business to Microsoft), but the cumulative licensing fees over a period of time could make this deal a low–return one in the long run. In addition, Lenovo would have had to invest significant amounts of resources on branding in developed markets.

Status quo would have helped the stock, but not the company in the long run

We also feel that status quo was not really an option, given the fast commoditizing Smartphone market and lack of differentiation at the low–end. Lenovo would also have faced a lot of litigation challenges from incumbents, once it achievesmeaningful size in non-China markets. Without adequate IP ownership, it would have been very difficult to enter into cross-licensing agreements and settle patent disputes.

Competing in the US is the toughest task

Of all the elements of the deal, raising the brand profile and gaining share in the US would be the most difficult task, in our view. We view the US Smartphone market as perfectly competitive, since there is very little distribution edge (carriers take care of most of the distribution). Product innovation and ecosystem lock-in are the key areas where brands can differentiate. In addition, most of the market is comprised of the mid-high end segment, since carrier subsidies are among the highest in the US (effectively reducing the upfront hardware cost for consumers).

Given the lack of a captive channel, the US market typically sees the rise and fall of new brands within short periods of time (LG in the early 2000's with its premium

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feature phones, Blackberry in mid 2000’s, HTC in the early Android Cycle, Samsung currently).

With Apple and Samsung accounting for ~70% of the US Smartphone market currently, we believe Lenovo-Motorola would have a tough task of taking market share and improving profitability at the same time. In addition, we believe that Samsung would outspend any other brand to try and defend its market share in mature markets like the US.

Figure 1: 3Q13 US smartphone unit share

Source: Counterpoint.

The operating environment among US carriers (focus on subsidy reduction and limit bargaining power of incumbent brands) do appear to be more favorable for a new entrant like Lenovo, but recent actions from Apple (offering iPhone 4 free of contract) and Samsung (whole range of products under the Galaxy umbrella) indicate that competition is likely to be fierce. However, we do believe that Lenovo can consolidate some market share from the smaller brands like HTC and LGE.

Significant Tail risk in US – entry of non-hardware players like Amazon into the smartphone market

We do not doubt that Lenovo can remain as competitive as the leading players like Samsung, despite much lower scale. But the real risk in the US market comes from the potential entry of non-hardware players like Amazon. With the extraordinary success of its Kindle Fire tablets and reports (Bloomberg) of Amazon moving into mobile payments, Smartphones could become the next area where Amazon steps into.

In case of such a move, we believe hardware margins would drop substantially for all traditional hardware players (just like it did for tablets when Google and Amazon stepped into this market), thus pushing out profitability and share gain opportunities for Lenovo-Motorola.

Apple, 33.7%

Samsung, 33.6%

LG, 8.6%

Nokia, 4.1%

Motorola, 3.7%

Others, 16.3%

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Motorola Proforma assumptions

We expect the deal to close by end of 2014 and contribution from Motorola will kick in from 4QFY15. Motorola was generating mid teens of gross margin prior to the acquisition but it slipped into negative op margin of 15+% each quarter with shrinking scale and heavy restructuring charges. After the acquisition, Motorola should enjoy better sales growth momentum with more aggressive pricing and synergy from channel distributions, product portfolio, etc. We’re currently expecting Motorola’s sales to grow by 50% in FY16E.

On the margin front, we believe Motorola’s loss in op margin could narrow to low single digit with better operating leverage and procurement cost savings due to some overlaps in supply chain.

Table 1: Motorola Mobile Profroma assumptions

4QFY15E 1QFY16E 2QFY16E 3QFY16E 4QFY16E FY14E FY15E** FY16ESmartphone Units (M) 6 7 8 10 9 15 18 34ASP (US $) 264 211 228 226 211 296 274 219

Revenue 1506 1479 1731 2262 1902 4,437 4,926 7,375QoQ / YoY 6% -2% 17% 31% -16% 11% 50%COGS 1250 1228 1420 1832 1521 3911 4128 6001Gross Margin 17.0% 17.0% 18.0% 19.0% 20.0% 11.9% 16.0% 20.0%Gross Profit 256 251 312 430 380 526 798 1373

OPEX (recurring) 377.9 337.5 387.1 481.4 444.435 1298 1365 1650OPEX ratio 25.1% 22.8% 22.4% 21.3% 23.4% 29.3% 28.8% 23.9%SGA 197 182 205 250 236 670 690 874R&D 180.9 155 182 231 208 628 675 776

Recurring EBIT * -122 -86 -75 -52 -64 -772 -567 -277Recurring EBIT Margins -8.1% -5.8% -4.4% -2.3% -3.4% -17.4% -11.5% -3.8%

Source: Company reports and J.P. Morgan estimates. * - ex stock based comp / restructuring / amortization; ** - Adjusted for full year basis

How quickly can Motorola turn around?

As illustrated in our proforma assumptions, we believe Motorola’s operating loss could contract to low single digit one year after Lenovo acquires it. While to get the business back to breakeven levels, we think that Lenovo may need to double the revenues of Motorola. This indicates that Motorola’s sales have to grow by another 35% in FY17E for Lenovo to turn it around, assuming good execution and strong operating leverage. However, the time frame looks still distant from now, and hence we don't expect any earnings contribution from Motorola for the next 12-18 months.

On the other hand, we believe IBM x86 server business could offer some buffer to the loss-making Motorola business; we expect profits from x86 server to cover the loss from Motorola from 3QFY16 on, and combined IBM & Motorola business could turn out to be breakeven in FY16E. Therefore we believe Lenovo could still leverage its leading position in the PC space to gain shares, grow in size and drive steady earnings growth in the upcoming years.

Table 2: Profit comparisons for IBM x86 & Motorola

4QFY15E 1QFY16E 2QFY16E 3QFY16E 4QFY16E FY15E FY16EIBM x86 EBIT 40 56 75 81 66 40 277Motorola EBIT -122 -86 -75 -52 -64 -122 (277)Combined EBIT -82 -30 -1 29 2 -82 0

Source: Company reports and J.P. Morgan estimates.

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P&L dilution for Lenovo

We forecast Motorola could add 14% additional sales for Lenovo in FY16E with an estimate of 30+ M smartphone shipment a year, or 2.6% of global market share. We believe such market share is achievable considering Lenovo’s strong execution and Motorola’s distinct brand awareness especially in Latam and EM, and don’t forget Motorola used to have 3+% of global share before being acquired by Google.

On the operating profit level, however, we estimate Motorola would dilute Lenovo's OP by ~15% in FY16E given the more time required for Lenovo to turn the business around.

Table 3: Lenovo earnings dilution from Motorola deal

Earnings accretion FY15E FY16E

Previous OP 1,277 1,718OP additional -10% -16%Previous Revenues 43,716 50,460Additional revenues 3% 15%Previous NP 946 1,242Additional Net Profit -8% -13%


Financing and Balance sheet after the deal

Lenovo has to pay US$750 mn in shares (5% dilution) and $660 mn in cash by the time the deal is finalized - likely by end of FY15, and another $1.5 bn of cash is payable 3 years after the closure of the deal.

To pay the consideration, we expect Lenovo to raise $1.2 bn of debt, which will make the company slip into slight net debt. While we believe Lenovo could recover to net cash within a year, given the negative CCC from PC and likely steady cashflow from server. Therefore we believe Lenovo still has a healthy balance sheet given its proven track record of cash generating abilities, which could be further strengthened when the Motorola business turns around.

Figure 2: Lenovo net cash trend

Source: Company reports and J.P. Morgan estimates. Period in Fiscal year

103%74%

100% 108%120% 128%

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1Q14 2Q14 3Q14E 4Q14E 1Q15E 2Q15E 3Q15E 4Q15E 1Q16E 2Q16E 3Q16E 4Q16E

Net cash Net cash to equity

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Earnings Revision

We maintain our FY14E forecast but revise down our FY15/16E earnings by 8/13% to factor in Motorola Mobile, whose contribution should kick off from 4Q FY15.We believe Motorola could bring 15% sales accretion to Lenovo in FY16E, while its serious operating loss would drag down Lenovo OP and earnings in the first year after acquisition.

Table 4: Earnings revision table

3QFY14E 4QFY14E FY15E FY16ENew Old Chg New Old Chg New Old Chg New Old Chg

Sales 10,603 10,603 0.0% 9,495 9,495 0.0% 45,221 43,716 3.4% 57,834 50,460 14.6%Gross profit 1,354 1,354 0.0% 1,190 1,190 0.0% 5,859 5,603 4.6% 8,126 6,753 20.3%Operating profit 323 323 0.0% 230 230 0.0% 1,155 1,277 -9.5% 1,441 1,718 -16.1%Net profit 245 245 0.0% 160 160 0.0% 874 946 -7.5% 1,082 1,242 -12.9%Blended gross margin 12.8% 12.8% 0.0% 12.5% 12.5% 0.0% 13.0% 12.8% 0.1% 14.1% 13.4% 0.7%Operating margin 3.0% 3.0% 0.0% 2.4% 2.4% 0.0% 2.6% 2.9% -0.4% 2.5% 3.4% -0.9%Net margin 2.3% 2.3% 0.0% 1.7% 1.7% 0.0% 1.9% 2.2% -0.2% 1.9% 2.5% -0.6%OPEX ratio 9.7% 9.7% 0.0% 10.1% 10.1% 0.0% 10.4% 9.9% 0.5% 11.6% 10.0% 1.6%

Source: J.P. Morgan estimates

Investment Thesis, Valuation and Risks

Lenovo Group Limited (Overweight; Price Target: HK$10.70)

Investment Thesis

We remain upbeat on Lenovo due to 1) its solid PC+ footprint with robust tablet / smartphone traction, 2) its ongoing PC share gain with strong channel support and acquisition efforts bearing fruit, 3) margin improvement on the way with rising scale, solid OPEX control and enhancing smartphone product mix.

Valuation

Our Mar-15 PT of HK$10.7 is based on 14x one year forward earnings. We expect some volatility in share price in the near term, while Lenovo's well proven M&A track record and its leading PC position keep us maintain OW.

Risks to Rating and Price Target

Key upside risk is if we see any faster-than-expected progress for x86 synergy,while key downside risk is slower growth in non-China markets for Lenovo,execution issue in tablet rollout and potential integration risk of Motorola business.

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Lenovo: Quarterly Earnings Model

FY13 FY14E FY15E(US$ in MM, year-end March) 1Q 2Q 3Q 4Q 1Q 2Q 3QE 4QE 1QE 2QE 3QE 4QE FY12 FY13 FY14E FY15E FY16E

Revenue 8,010 8,673 9,359 7,832 8,787 9,774 10,603 9,495 10,110 10,956 11,364 12,792 29,574 33,873 38,659 45,221 57,834COGS (Excl Dep) -6,916 -7,482 -8,119 -6,718 -7,538 -8,449 -9,204 -8,260 -8,782 -9,524 -9,864 -11,032 -25,953 -29,235 -33,450 -39,202 -49,548Gross Profit 1,047 1,140 1,190 1,052 1,191 1,265 1,354 1,190 1,288 1,391 1,460 1,720 3,446 4,428 5,002 5,859 8,126Operating Expense -865 -933 -967 -883 -990 -981 -986 -915 -955 -1,008 -1,060 -1,520 -2,688 -3,648 -3,872 -4,544 -6,525EBITDA

229 257 273 231 260 343 413 320 373 423 440 240

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990

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1,475

1,761 Depr'n and amort'n -48 -51 -30 -62 -58 -59 -90 -90 -80 -80 -80 -80 -351 -210 -149 -160 -160EBIT 182 207 243 169 202 283 323 230 293 343 360 160 583 800 1,039 1,155 1,441Net Interest Income 4 -1 3 -3 -2 -13 -9 -6 -5 -3 -2 -12 86 45 40 55 26Net Other Income 0 -1 0 0 16 -5 0 0 0 0 0 0 -87 -44 -60 -77 -102Pre Tax Profit 185 205 246 166 216 265 315 224 288 340 357 148 582 802 1,019 1,134 1,365Tax -41 -41 -46 -42 -46 -51 -63 -56 -58 -68 -71 -33 -107 -170 -216 -230 -245Preferred dividend 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0Minorities -3 -1 5 3 4 6 -7 -9 -6 -7 -7 -9 -2 4 -6 -30 -37Net Profit 141 163 204 127 174 219 245 159 224 265 279 106 473 635 797 874 1,082Core Net Profit 141 163 204 127 174 219 245 159 224 265 279 106 472 635 797 874 1,082Core EPS (US$) 0.0134 0.0155 0.0193 0.0119 0.0165 0.0208 0.0233 0.0152 0.0213 0.0253 0.0261 0.0095 0.0465 0.0616 0.0767 0.0825 0.0977Margins (%)Gross Margin 13.1 13.1 12.7 13.4 13.6 12.9 12.8 12.5 12.7 12.7 12.8 13.4 11.7 13.1 12.9 13.0 14.1Operating Margin 2.3 2.4 2.6 2.2 2.3 2.9 3.0 2.4 2.9 3.1 3.2 1.3 2.0 2.4 2.7 2.6 2.5EBITDA Margin 2.9 3.0 2.9 2.9 3.0 3.5 3.9 3.4 3.7 3.9 3.9 1.9 0.1 1.1 1.6 1.5 1.5Net Margin 1.8 1.9 2.2 1.6 2.0 2.2 2.3 1.7 2.2 2.4 2.5 0.8 1.6 1.9 2.1 1.9 1.9Q/Q Growth (%)Revenue 6.8 8.3 7.9 -16.3 12.2 11.2 8.5 -10.4 6.5 8.4 3.7 12.6 n.a. n.a. n.a. n.a. n.a.Gross Profit 29.9 8.9 4.4 -11.5 13.2 6.1 7.1 -12.1 8.2 8.0 4.9 17.8 n.a. n.a. n.a. n.a. n.a.EBIT 79.1 13.7 17.5 -30.2 19.1 40.5 14.0 -28.7 27.0 17.2 4.8 -55.5 n.a. n.a. n.a. n.a. n.a.Core Net Profit 114.0 15.4 25.2 -37.8 37.1 25.9 11.8 -35.0 40.6 18.6 5.1 -62.0 n.a. n.a. n.a. n.a. n.a.Core EPS 114.1 16.1 24.4 -38.5 38.7 26.1 12.1 -35.0 40.6 18.6 3.3 -63.7 n.a. n.a. n.a. n.a. n.a.Y/Y Growth (%)Revenue Growth 35.3 11.4 11.8 4.5 9.7 12.7 13.3 21.2 15.1 12.1 7.2 34.7 37.0 14.5 14.1 17.0 27.9Gross Profit 41.7 20.2 24.7 30.6 13.8 11.0 13.8 13.1 8.1 10.0 7.8 44.5 45.8 28.5 12.9 17.1 38.7EBIT 47.6 24.4 26.3 66.9 11.0 37.2 33.1 36.1 45.1 21.1 11.3 -30.5 52.7 37.3 29.8 11.2 24.7Core Net Profit 29.9 12.7 34.0 92.1 23.1 34.4 20.0 25.5 28.7 21.1 13.9 -33.4 72.9 34.7 25.5 9.7 23.8Core EPS 23.5 12.2 33.4 90.2 23.3 34.0 20.7 27.5 29.3 21.5 11.9 -37.6 65.0 32.4 24.6 7.6 18.3

Source: Company reports and J.P. Morgan estimates

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Lenovo Group Limited: Summary of FinancialsIncome Statement Ratio Analysis

$ in millions, year end Mar FY12 FY13 FY14E FY15E FY16E $ in millions, year end Mar FY12 FY13 FY14E FY15E FY16E

Revenues 29,574 33,873 38,659 45,221 57,834 Gross margin 11.7% 13.1% 12.9% 13.0% 14.1%

Cost of goods sold (25,953) (29,235) (33,450) (39,202) (49,548) EBITDA margin 3.2% 2.9% 3.3% 3.3% 3.0%Gross Profit 3,446 4,428 5,002 5,859 8,126 Operating margin 2.0% 2.4% 2.7% 2.6% 2.5%

R&D expenses (453) (623) (645) (682) (979) Net margin 1.6% 1.9% 2.1% 1.9% 1.9%

SG&A expenses (2,246) (3,090) (2,718) (2,726) (3,915) R&D/sales 1.5% 1.8% 1.7% 1.5% 1.7%Operating profit (EBIT) 583 800 1,039 1,155 1,441 SG&A/Sales 7.6% 9.1% 7.0% 6.0% 6.8%EBITDA 934 990 1,279 1,475 1,761

Interest income 43 45 40 55 26 Sales growth 37.0% 14.5% 14.1% 17.0% 27.9%Interest expense (43) (43) (71) (77) (102) Operating profit growth 52.7% 37.2% 29.9% 11.2% 24.7%

Investment income (Exp.) (1) 2 (31) (22) (76) Net profit growth 73.1% 34.3% 25.6% 9.6% 23.8%Non-operating Income (expense) - - - - - EPS (reported) growth 65.1% 32.0% 24.7% 7.5% 18.3%

Earnings before tax 582 801 1,019 1,134 1,365

Tax (107) (170) (216) (230) (245) Interest coverage (x) 1,181.9 NM 41.9 68.0 23.2Net income (reported) 473 635 798 874 1,082Net income (adjusted) 473 635 798 874 1,082 Net debt to total capital 361.4% 403.1% 1363.4% 1.3% (14.2%)

Net debt to equity NM NM NM 1.3% NMEPS (reported) 0.05 0.06 0.08 0.08 0.10EPS (adjusted) 0.05 0.06 0.08 0.08 0.10 Asset turnover 2.2 2.1 2.2 2.2 2.3

BVPS 0.26 0.23 0.28 0.35 0.43 Working capital turns (x) NM 219.3 668.8 NM NMDPS 0.02 0.03 0.03 0.03 0.03 ROE 22.1% 27.5% 33.0% 29.6% 29.7%

Shares outstanding 10,137 10,315 10,389 10,592 11,080 ROIC - - - - -

Balance sheet Cash flow statement

$ in millions, year end Mar FY12 FY13 FY14E FY15E FY16E $ in millions, year end Mar FY12 FY13 FY14E FY15E FY16E

Cash and cash equivalents 3,758 3,454 3,714 2,000 2,546 Net income 473 635 798 874 1,082Accounts receivable 2,994 3,458 3,968 5,345 5,795 Depr. & amortization - 38 150 160 160

Inventories 1,218 1,965 2,081 2,804 3,050 Change in working capital 844 (787) 467 192 (250)Others 3,850 3,513 3,517 4,029 4,123 Other (857) (105) 6 30 37

Current assets 11,820 12,390 13,279 14,178 15,514 Cash flow from operations 460 (219) 1,420 1,256 1,030LT investments 35 46 57 5,257 5,257 Capex (430) (377) - 0Net fixed assets 496 669 759 742 739 Disposal/(purchase) 0 (5) (9) 0 0

Others 3,509 3,782 3,840 3,840 3,840 Cash flow from investing (411) (393) (20) (5,200) 0Total Assets 15,861 16,887 17,935 24,016 25,350 Free cash flow 30 (602) 1,435 1,273 1,092Liabilities Equity raised/(repaid) 0 0 0 0 0

ST Loans 373 569 842 842 842 Debt raised/(repaid) (148) 196 0 1,200 0Payables 4,178 3,724 4,707 6,287 6,530 Other 765 507 (298) 1,487 0

Others 7,259 7,798 7,912 9,137 9,434 Dividends paid (187) (246) (311) (317) (326)Total current liabilities 11,810 12,091 13,462 16,266 16,806 Cash flow from financing 754 (384) (324) 1,963 (734)Long-term debt 0 0 0 1,200 1,200 Net change in cash 803 (996) 1,077 (1,982) 295

Other liabilities 1,603 2,110 1,813 3,300 3,300 Beginning cash 2,954 3,758 3,454 3,714 2,000Total Liabilities 13,413 14,202 15,274 20,766 21,306 Ending cash 3,758 3,454 3,714 1,998 2,547Shareholder's equity 2,448 2,169 2,661 3,250 4,044


10



JPM Q-ProfileLenovo Group Limited (CHINA / Information Technology)As Of: 24-Jan-2014 [email protected]

Local Share Price Current: 10.44 12 Mth Forward EPS Current: 0.09

Earnings Yield (& local bond Yield) Current: 6% Implied Value Of Growth* Current: 25.86%

PE (1Yr Forward) Current: 15.8x Price/Book Value Current: 5.1x

ROE (Trailing) Current: 28.43 Dividend Yield (Trailing) Current: 2.12

Summary

Lenovo Group Limited 13837.08 As Of:

CHINA 35.45836 SEDOL 6218089 Local Price: 10.44

Information Technology Computers & Peripherals EPS: 0.09

Latest Min Max Median Average 2 S.D.+ 2 S.D. - % to Min % to Max % to Med % to Avg12mth Forward PE 15.83xP/BV (Trailing) 5.11x 1.18 24.59 4.02 5.41 13.22 -2.41 -77% 381% -21% 6%

Dividend Yield (Trailing) 2.12 0.08 9.51 1.66 1.77 4.69 -1.15 -96% 349% -22% -17%

ROE (Trailing) 28.43 -9.82 33.81 18.22 16.69 39.96 -6.58 -135% 19% -36% -41%

Implied Value of Growth 25.9% -1.12 1.10 0.34 0.38 0.98 -0.22 -533% 325% 30% 46%

Source: Bloomberg, Reuters Global Fundamentals, IBES CONSENSUS, J.P. Morgan Calcs * Implied Value Of Growth = (1 - EY/Cost of equity) where cost of equity =Bond Yield + 5.0% (ERP)

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11



Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. For all Korea-based research analysts listed on the front cover, they also certify, as per KOFIA requirements, that their analysis was made in good faith and that the views reflect their own opinion, without undue influence or intervention.

Important Disclosures

Client: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients: Lenovo Group Limited.

Company-Specific Disclosures: Important disclosures, including price charts, are available for compendium reports and all J.P. Morgan–covered companies by visiting https://jpmm.com/research/disclosures, calling 1-800-477-0406, or e-mailing [email protected] with your request. J.P. Morgan’s Strategy, Technical, and Quantitative Research teams may screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call 1-800-477-0406 or e-mail [email protected].

Date Rating Share Price (HK$)

Price Target (HK$)

24-Oct-06 N 3.45 3.50

12-Nov-06 N 3.08 3.00

01-Feb-07 N 3.17 3.20

24-May-07 N 3.21 4.00

27-Jul-07 N 4.63 5.40

03-Aug-07 N 5.20 6.20

05-Nov-07 N 8.26 9.50

10-Jan-08 N 5.54 9.00

31-Jan-08 N 5.37 7.00

22-Jul-08 N 5.30 6.10

28-Oct-08 N 2.59 2.35

10-Nov-08 N 1.92 1.95

28-Nov-08 UW 1.79 1.45

06-Feb-09 UW 1.46 1.19

09-Aug-09 UW 3.93 3.20

05-Nov-09 UW 4.44 3.40

09-Feb-10 UW 5.23 4.20

05-May-10 N 5.84 6.00

05-Aug-10 N 5.24 5.50

20-Aug-10 N 4.75 4.90

01-Dec-10 OW 5.22 6.30

21-Mar-11 OW 4.18 5.80

05-Jul-11 OW 4.64 5.80

03-Nov-11 OW 5.34 6.60

10-Feb-12 OW 6.25 7.20

18-May-12 OW 6.61 8.50

07-Jun-12 OW 6.53 8.10

27-Jan-13 OW 8.22 9.20

12-Apr-13 OW 7.53 8.60

23-May-13 OW 7.38 9.00

07-Nov-13 OW 8.42 10.00

21-Jan-14 OW 10.18 11.70

26-Jan-14 OW 10.44 12.50

0

7

14

21

Price(HK$)

Oct06

Apr08

Oct09

Apr11

Oct12

Lenovo Group Limited (0992.HK, 992 HK) Price Chart

N HK$3.2N HK$6.2N HK$7 N HK$1.95 UW HK$4.2N HK$4.9 OW HK$8.5 OW HK$9OW HK$12.5

N HK$3 N HK$5.4N HK$9 N HK$2.35UW HK$1.19UW HK$3.4N HK$5.5 OW HK$7.2 OW HK$8.6OW HK$11.7

N HK$3.5N HK$4N HK$9.5N HK$6.1UW HK$1.45UW HK$3.2 N HK$6OW HK$6.3OW HK$5.8OW HK$5.8OW HK$6.6OW HK$8.1OW HK$9.2OW HK$10

Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.

Initiated coverage Oct 24, 2006.

mailto:[email protected]


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12



The chart(s) show J.P. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire period. J.P. Morgan ratings or designations: OW = Overweight, N= Neutral, UW = Underweight, NR = Not Rated

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Coverage Universe: Hariharan, Gokul: ASE (2311.TW), ASUSTek Computer (2357.TW), Acer Inc (2353.TW), Delta Electronics, Inc. (2308.TW), Hon Hai Precision (2317.TW), Lenovo Group Limited (0992.HK), Pegatron Corp (4938.TW), Quanta Computer Inc. (2382.TW), SMIC (0981.HK), SPIL (2325.TW), UMC (2303.TW)

J.P. Morgan Equity Research Ratings Distribution, as of January 1, 2014

Overweight(buy)

Neutral(hold)

Underweight(sell)

J.P. Morgan Global Equity Research Coverage 43% 45% 12%IB clients* 57% 49% 36%

JPMS Equity Research Coverage 43% 50% 7%IB clients* 75% 66% 59%

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Documents

Lenovo Group Limited Overweightpg.jrj.com.cn/acc/Res/HK_RES/STOCK/2014/2/3/d55e20...Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Price Performance 0992.HK share price (HK$) MSCI-Cnx (rebased)