Performance lag

Lenovo deals need cost control spark to compute

Lenovo is trying to make a habit of turning around Western technology brands. The Chinese electronics group revived IBM's personal computer unit after buying the business in 2005. Now it has finalised the purchases of low-end IBM servers and Motorola smartphones for a combined $5 billion in stock and cash. With few obvious cost synergies on offer, Lenovo needs to jolt revenue growth and rein in spending in order to earn a return.

Upstart Chinese competitors have squashed margins for both servers and smartphones. Lenovo's new purchases are ailing. Though Motorola's third-quarter revenue was 51 per cent higher than in the previous year, the business made a net loss of $185 million. Revenue at IBM's loss-making server unit revenue fell 10 per cent to $990 million in the same period, according to Bernstein analysts.

Cost-cutting may help. Motorola could slash spending on research and use Lenovo's factories, though it's far from clear how that will help to re-energise the brand in the hyper-competitive mobile phone business. IBM could renegotiate component costs from Chinese suppliers.

Lenovo has not spelt out any cost synergies from the deals, which suggests they are quite small or don't exist. That makes it harder for the Chinese group to earn a return. If Motorola's revenue grows by 60 per cent in the three years to March 2017, operating margins will need to reach around 2.4 per cent in order for the deal to exceed Lenovo's cost of capital, according to Breakingviews calculations based on an 11 per cent cost of equity and borrowing costs of 4.74 per cent. That looks tough given Motorola's small handset production scale. To break even on the IBM deal, Lenovo needs boost the unit's revenue by about 30 per cent and get operating margins to two per cent over three years.

Investors seem to be giving Lenovo the benefit of the doubt. Its shares are trading close to the level before the company unveiled its Motorola acquisition in January. To justify that faith, Lenovo will need to demonstrate that turning around Western technology brands is becoming a habit.