During the Depression-ridden 1930s, with the United States circling the financial abyss, an American industrialist named Thomas J. Watson Jr. gambled the future of his business-equipment company on an expansion plan that included wholesale hiring, investments in technology, and the construction of new factories.
For six years, Watson had his factories at full bore – churning out tabulating equipment there were no buyers for. But he believed in his plan and stayed with his strategy.
When the Social Security Act of 1935 came up for bid – billed as “the biggest accounting operation of all time” – Watson’s company was the only firm able to supply the equipment needed to maintain the employment records of 26 million people.
The successful execution on this contract led to other government pacts. Not only did this allow Watson’s company to navigate the Depression; it set it up for long-term success.
That company went on to become one of the most-successful computer firms in history – the venture we now know as International Business Machines Corp. (NYSE: IBM).
“Big Blue,” as the company is also known, has been experiencing some tough problems in recent months. But its successful years made fortunes for many investors.
We believe investors can reap the same windfall from the company that’s poised to replace IBM as the new king of the computer industry.
We’ve identified that successor – and are going to bring it to you today.
From Leader to Laggard
Back on Jan. 21, IBM announced that fourth quarter sales had fallen 5%.
That sounds like the kind of small decline that really shouldn’t worry investors. After all, profits rose about 6% from the year-ago quarter to about $6.2 billion.
But this was the seventh straight quarter that revenue fell. And Big Blue said it was taking a $1 billion first-quarter hit to cover restructuring costs.
Even as IBM tries to make itself over – which it has successfully done before – another firm is poised to take its place at the head of the sector table.
That company is Lenovo Group Ltd. (OTC: LNVGY). And it’s poised to become the “Next IBM“ – and Big Blue is helping make this happen.
Let’s Make a Deal
On Jan. 23, Lenovo agreed to pay $2.3 billion for Big Blue’s low-end server business. This is the second major deal between the two companies in less than a decade; Lenovo bought IBM’s struggling PC business back in 2005.
Founded in a Chinese guard shack back in 1984, Beijing-based Lenovo today stands as the world’s largest PC company. It’s also a leading global supplier of smartphones and tablet computers.
Buying IBM’s server unit makes a lot of sense. Despite all its experience, IBM couldn’t keep costs under control and still compete in a global market. Last year, the so-called “x86” server line lost $26.4 million.
But Lenovo is known for its strict cost discipline. Bernstein Research notes that IBM had a cost ratio of more than 20% of sales. Lenovo, on the other hand, generally keeps those costs at around 10%.
The deal automatically transforms Lenovo into the world’s No. 3 vendor of these servers, giving it a 14% share worldwide and $4.7 billion in sales.
In Lenovo’s home market of China, sales of these servers are expected to grow between 5% a year and 8% a year – more than twice the industry growth rate – as the world’s most populous nation builds new computer data centers to keep up with its economic growth.
This acquisition hands Lenovo some excellent built-in synergies. With its global supply chain, it can roll out this business very quickly – incurring only nominal additional costs for their distribution.
More to the point, the company also quietly agreed to take roughly 7,500 IBM workers as part of the package. Many of these are longtime employees who know the server market inside and out.
That alone will save Lenovo millions in hiring costs. It also gives them access to many of the employees who helped build the business and know where to look for hidden efficiencies.
And Lenovo has deep experience in taking the units that no longer fit IBM and creating enormous shareholder value.
When Lenovo bought IBM’s PC business in 2005, the Chinese upstart had a 6.4% market share. Today, that figure stands at nearly 17%. It’s the only PC firm with any significant market share gains over the last decade.
On a personal note, my wife is one of the reasons why Lenovo is doing so well with its PCs. She’s a technology expert and oversees the IT department at work.
She recently got a new Lenovo ThinkPad Yoga that she just loves. It’s perfect for a busy professional — the Yoga functions as both a laptop and a tablet.
For Lenovo to make a device that can impress a seasoned veteran says a lot about the firm’s high design and production standards.
That’s critical because the market is clearly going mobile, where smart phones and tablets outsell PCs by a factor of 5-to1. But this vital stat doesn’t have Lenovo worried.
Instead, the firm sees itself as a leader in what it calls the"PC+ world" that links multiple devices in a tech ecosystem.
And market researcher IDC agrees. It recently ranked Lenovo as No. 3 in market share for “smart connected devices” that combine PCs, smartphones and tablets.
It’s hitting the mobile world hard. Lenovo ranks fourth in global sales of both tablets and smart phones with a roughly 4.8% share, according to IDC and internal research.
For smartphones alone, it plans to enter 20 new markets by the middle of this year. That follows a 72% year-over-year gain in the second quarter.
And another new deal will help Lenovo achieve its goals.
Let’s Make a Deal (II)
Just this week, Lenovo announced that it’s buying the Motorola phone business owned by search giant Google Inc. (Nasdaq: GOOG) for $2.9 billion.
The acquisition is a shrewd one for Lenovo that will turn Google’s failure into a major success that already fits into the Chinese company’s long-range strategic plan. Lenovo already ranks fourth in the world in both smartphones and tablets. This should supercharge its growth efforts in the mobile realm.
It also opens up a lot of unique marketing and branding opportunities. For instance, it can sell the Lenovo-branded phones in Asia and Motorola ones in the U.S. and European markets.
But it also can reverse-migrate the phones, selling a premium unit like “Motorola by Lenovo” in China, and then “Lenovo by Motorola” in the United States.
Clearly, this is a company that is transforming itself into a global high-tech powerhouse.
The company has a market value of $13 billion, and its shares trade at roughly $25 a share. The company has a 27% return on stockholders’ equity (ROE) and recently grew quarterly earnings by 35%. The shares trade at roughly 15 times projected 2015 earnings.
I’d like to see higher profit margins. But I think that will follow in the next couple of quarters because earnings are growing twice as fast as sales.
The bottom line: I believe the stock could gain 50% over roughly the next year – making this the kind of high-return “special-situation” play that are so tough to find.
These high-probability profit plays create a nice foundation that allows us to pursue the more-aggressive double-your-money profit opportunities that are the focus of the Strategic Tech Investor.
In fact, as I’ve mentioned over the last several weeks, stocks aren’t the only investment that I’m watching closely right now
I’ve also got my eye on a phenomenon that is white-hot.
I’m referring to “Bitcoins.”
If you’ve been following the headlines about Bitcoins of late, you know that the “virtual currency” recently soared from $131 to $1,150 in just the past two months – a return of 778%.
It has recently settled down a bit, trading consistently around $900 a Bitcoin. But to me the that just means the buying opportunity is better than ever. Not to mention it’s one heck of a story.
Whether you get involved with Bitcoin now, or want to think about it for the future, I’ve put together an amazing way for you to learn everything about it. Take a look here and you’ll see what I mean.
[Editor’s Note: Michael values your comments. Tell us how you’re doing with the companies you’ve heard about here and what you’d like to see in the future. Your comments will be very useful in making Strategic Tech Investor the best free tech e-letter around.]