Lenovo: Not Your Father's PC Company Anymore

Why Lenovo could be a decent trade as the market is myopically focused on PC shipments, overlooking services profitability and servers inflection

Lenovo (992 HK) could be a decent trade. Valued potentially at 4x EV/EBIT three years out, a re-rating to its historical 8x EV/EBIT multiple would deliver a double within that timeframe. The market appears to be overly focused on its PC business, ignoring that its services segment is increasingly a significant profit engine. No longer simply a traditional PC manufacturer largely reliant on next year’s unit shipments, the company is undergoing a strategic transformation driven by the growth of stable, recurring high-margin service revenue and a profitability inflection in its servers business.

Why is this mispriced? Investor sentiment soared over the few months, buoyed by the looming end-of-life for Windows 10 and the advent of AI PCs. Hopes for a massive upgrade cycle were high; this was crucial, as global PC shipments had stagnated for years, and these two factors held the potential for meaningful upside. Yet, the anticipated demand surge ultimately did not occur on both fronts.

Windows 10 EOL has been telegraphed since 2021 with (somewhat) annual reminders from Microsoft. Corporates have already been slowly upgrading their PC fleet once Windows 11 debuted. Hence, the view that there would be a significant upgrade cycle once EOL goes into effect in October 2025 is likely misguided.

AI PCs represent a bet on edge AI. This technology, however, is truly essential only for latency-sensitive applications. Consider autonomous driving: the delay involved in transmitting data to the cloud and back is simply unacceptable, necessitating on-device processing. Such critical use cases are uncommon in commercial PC applications. The anticipated dramatic increase in PC unit shipments thus never materialized.

This excitement and eventual disappointment from the aforementioned two factors likely explains the share price peaking at HK$12-13 in early 2025 and falling to its current HK$8-9 range. It also largely confirms the assertion that the market still views Lenovo as a PC manufacturer (as these drivers mainly affect PC demand), only deserving to trade at roughly 9x NTM P/E and 6x NTM EV/EBIT. In my view, the multiple and forward top- and bottom-line numbers are low.

Why now? Despite the anticipated step-function increase in PC unit shipments not materializing, the mix shift towards AI PC is ongoing. Eventually, almost every PC on the market is going to be an AI PC. This will be driven by OEMs rather than consumers and corporates; AI PCs may not be what the market demands, but it will be what OEMs stock. Average selling prices for AI PCs are 10-15% higher than traditional PCs (mostly due to the NPU) and hence the upgrade cycle has been gradual, mirroring replacement demand. Despite the ASP uplift, most of this will accrue to the chip designers. A simple test case is COVID: Lenovo PC sales peaked in FY21/22 but the segment only managed 50 bps of margin expansion on a 7% operating margin business. If the company could not raise prices significantly in the hottest PC market in a decade, it is unlikely to be able to take price on the shift to AI PCs. After all, Lenovo did not make the CPU, GPU, memory or any of the chips in the device; its role is simply to assemble and distribute the end product.

This is also evident as IDG, the segment comprising mostly of Lenovo’s PC business (and the old Motorola smartphone division) that accounts for nearly 70% of consolidated revenue, grew low-double digits in FY24/25 while industry-wide unit shipments grew low single-digits, with the delta likely being explained by Lenovo gaining some market share and said ASP uplift. PC is a mature and consolidated market, with Lenovo having roughly 24% of global market share, followed by Dell and HPE at roughly 20% and 16% respectively, and smaller players such as Apple, Acer and Asus at single-digits. Given the narrow gap between the top three, and the largely commoditized nature of the product (mostly assembly and distribution), competitive advantages are small and stem from low costs and advertising scale. Essentially, this is an average, not great business. This segment’s growth will continue over the next few years as AI PC penetration increases, likely driving high single-digit growth for IDG. In three years (FY27/28), IDG could generate $4.3b in segment EBIT.

In addition, ISG, the segment comprising Lenovo’s server business accounting for 20% of consolidated revenue, is at an inflection point. Like its main OEM competitors (i.e. Dell and HPE), Lenovo was caught flat-footed when AI server demand exploded a few years ago. Hyperscalers like Amazon, Microsoft, Google, and Meta, driven by a need for rapid time-to-market and minimizing costs, bypassed traditional OEMs entirely. They went directly to ODMs such as Quanta, Wiwynn, and Foxconn, procuring massive volumes of white-label AI servers specifically customized to their unique requirements.

Given that hyperscaler procurement volumes are in the tens of billions, even minor per-server unit cost savings translate into substantial reductions in total cost of ownership. ODMs offered significantly lower costs, as they lack the overhead expenses associated with OEMs, including branding, extensive sales teams, and service networks. This allowed hyperscalers to avoid the premium markups typically charged by OEMs. Furthermore, ODMs provided deep customization capabilities (component choice, form factors, power delivery, and cooling solutions) all precisely tailored to the hyperscalers' distinct software stacks, workloads, and data center environments. In contrast, OEMs generally had to cater to a much broader spectrum of enterprises, both small and large, necessitating more standardized product offerings. Consequently, ODMs have likely captured approximately 47% of the global server market share.

Dell and HPE pivoted in response. They moved beyond mere hardware sales, bundling their offerings with services and solutions (Dell APEX and HPE GreenLake, their respective as-a-Service models). This leveraged a critical ODM weakness: the lack of non-hardware capabilities. Lenovo, however, pursued a different strategy. They brought server design, engineering, and manufacturing largely in-house, essentially integrating upstream. This granted them ODM-like cost structures while retaining tight control over quality, customization, and service delivery. They also launched their own as-a-Service offerings across the hardware lifecycle. Basically, Lenovo front-loaded significant infrastructure spending over the past few years, heavily investing in the capabilities required to meet hyperscaler demand. This investment explains the segment's unprofitability during that period.

Importantly, this segment has broken even, with segment operating margins expanding from -2.8% in FY23/24 to -0.5% in FY24/25 and breakeven in Q3 and Q4 FY24/25, with incremental operating margins of roughly 3% in FY24/25. ISG grew 63% in FY24/25, with 85% of incremental revenue driven by hyperscaler demand, which is now 70% of ISG revenue. Given all of the major OEMs and ODMs have 5-7% market share individually (Dell is tied #1 with Supermicro at roughly 7%, Lenovo is tied #2 with HPE at roughly 5%), margins will likely remain thin for years. IDC suggests the global server market could grow mid-teens through the end of the decade and if Lenovo matches that rate (conservative, as it has been outgrowing Dell and HPE), and attain a 4% segment operating margin (materially below ODMs such as Quanta and Wiwynn), ISG could drive $900m in segment EBIT in FY27/28.

Furthermore, SSG, the segment comprising Lenovo’s services business, is potentially underappreciated. Despite accounting for roughly 10% of consolidated segment revenue, it drives an outsized amount of profits given its 21% operating margins, which is thrice that of IDG. SSG has been growing at low-teens, a trend which would likely continue given its growing installed base in PC and servers, and could produce $2.5b in segment EBIT in FY27/28.

In total, the company’s three segments could generate $7.7b in segment EBIT. Note that the three segments do sell to one another and thus there are intercompany eliminations to account for. Total segment revenue minus consolidated revenue represents the revenue portion of intercompany eliminations. Historically, intercompany revenue eliminations have accounted for 6-7% of total pre-elimination revenues at a 30% operating margin. Based on my numbers, Lenovo would be at roughly $96b in total segment revenue in FY27/28, implying $5.9b in intercompany revenue and $1.8b in intercompany operating income. Thus, total segment EBIT after eliminations in FY27/28 would be $5.9b.

HQ costs are about 2% of total segment revenue while corporate D&A is about 0.8%, amounting to $2.6b in FY27/28, resulting in $3.3b in consolidated EBIT, implying roughly 4x EV/EBIT on current EV with net cash in FY27/28 of under a billion. The reason why cash generation is much less than a few years ago is due to the revenue mix shift to ISG which is a much more working capital-intensive than the core PC business and hence out-year cash generation will be more limited compared to early 2020s.

Conclusion

While the market has historically viewed Lenovo primarily as a PC manufacturer, its strategic transformation and the increasing importance of its services and server segments present a decent mispricing. The muted impact of Windows 10 EOL and AI PCs on unit shipments has overshadowed the significant growth and profitability potential in Lenovo's other divisions. With IDG benefiting from AI PC penetration, ISG reaching an inflection point due to vertical integration and hyperscaler demand, and SSG consistently growing high-margin recurring revenue, Lenovo is poised for high-teens EBIT growth in the coming years. This shift in profit mix, moving away from an enormous reliance on PC sales, suggests that Lenovo is undervalued as non-PC segments continue to mature and contribute to consolidated profitability. However, given intense competitive dynamics, commoditized markets, and average business quality at best, the idea should be viewed as more of a trade rather than a long-term opportunity.

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