More on inventory risk, how Cisco's writeoff helps ECMs:
zdii.com
The good news and bads news in a nutshell (entire article follows this excerpt):
<<Analysts said it's impossible to know how much of
Cisco's inventory its outsourcing partners were holding,
but it was enough to rattle EMS shares leading up to
the networking giant's profit warning.
Paul Fox, an analyst at Banc of America, said Cisco's
write-down "probably relieves at least some of the
pressure that this inventory issue has been generating."
But there's still pressure. Although the inventory risk
has waned for contract equipment vendors, Cisco's
profit warning, along with Nortel's and a host of other
telecom equipment companies' warnings, can't be good
news. Jabil gets 16 percent of its sales from Cisco;
followed by Solectron, 12 percent; Flextronics
International (Nasdaq: FLEX) and Sanmina (Nasdaq:
SANM), 10 percent; and Celestica (NYSE: CLS), 5 to
10 percent. >>
THE DAY AHEAD: Your write-off or
mine?
By Larry Dignan TDAIN ZDII
COMMENTARY--Cisco Systems is in the running for
partner of the year. Instead of leaving its
outsourcing partners with tons of excess inventory
for another quarter, the networking giant stepped
up to the plate and said it will take a huge $2.5
billion inventory write-off in its April quarter. The
move also saved the stocks of Jabil Circuit,
Solectron and their peers.
Networking-equipment giant Cisco outsources most of
its manufacturing to companies such as Jabil (NYSE:
JBL) and Solectron (NYSE: SLR), which make the final
products for other companies. And Cisco isn't alone.
Cisco rival Nortel Networks (NYSE: NT) as well as PC
makers all outsource manufacturing. Hewlett-Packard
(NYSE: HWP) is already planning an inventory
write-down.
That's why Cisco's inventory write-off was seen as good
news for electronics manufacturing services (EMS)
companies, also known as contract equipment
manufacturers. In English, these firms make stuff for
other companies that don't want to build their own
plants.
Why was Cisco's write-down such a big deal to its
partners? Cisco could have strung along EMS
companies and left them with bloated inventory levels.
Here's why Cisco took the write-down. If a contract
equipment vendor had to take a big inventory
write-down, it would have hurt sentiment on the whole
industry, said Goldman Sachs analyst Michael Zimm.
EMS stocks are popular because there isn't supposed
to be much inventory risk.
Now Cisco has set a trend by basically handing a
check to its EMS partners. Cisco CEO John Chambers
said the write-off was important to maintain good
relations with Solectron and Jabil.
The conversation may have went like this:
Chambers: Whe-wee…we have 100-year flood of
inventory.
EMS folks: Tell us about it. We're holding way to
much of your raw material.
Chambers: Your write-down or mine?
EMS folks: It's your inventory and our contract
says you get the write-down anyway. All yours.
Chambers: Damn.
"The inventory write-off is good news as it highlights
Cisco's continued acceptance of responsibility for
inventory, something for which it is contractually
responsible anyway, but has been called into question
just the same. We believe the majority of other large
OEMs will likely behave in a similar fashion," said ING
Barings analyst Patrick Parr.
Simply put, shareholders of contract manufacturing
companies breathed a sigh of relief over the Cisco
charge. The contract equipment business model hinges
on low inventory risks. Under the usual terms of
engagement, the inventory risks rest with the OEMs
(original equipment manufacturers.)
However, the IT spending meltdown put contract
equipment companies to the test. "If there ever was to
be a significant test of the (outsourced) business
model, particularly from what is arguably the industry's
most important customer with the industry's worst
inventory problem, this was it," Zimm said.
Getting stuck with inventory is no small matter--for any
company. When most manufacturing is outsourced
things can get really sticky. Cisco's inventory for its
April quarter ballooned to $4.1 billion. That's a banner
year in sales for most companies.
Analysts said it's impossible to know how much of
Cisco's inventory its outsourcing partners were holding,
but it was enough to rattle EMS shares leading up to
the networking giant's profit warning.
Paul Fox, an analyst at Banc of America, said Cisco's
write-down "probably relieves at least some of the
pressure that this inventory issue has been generating."
But there's still pressure. Although the inventory risk
has waned for contract equipment vendors, Cisco's
profit warning, along with Nortel's and a host of other
telecom equipment companies' warnings, can't be good
news. Jabil gets 16 percent of its sales from Cisco;
followed by Solectron, 12 percent; Flextronics
International (Nasdaq: FLEX) and Sanmina (Nasdaq:
SANM), 10 percent; and Celestica (NYSE: CLS), 5 to
10 percent.
"Cisco management did little to suggest that market
conditions for communications hardware are likely to
improve anytime soon, with the U.S. weakness
spreading globally--not good news, in our view, when
this hardware segment comprises about 40 to 50
percent of the top-tier EMS firms' sales," Parr said.
Other ripple effects
Chip equipment makers should rejoice at Cisco's
write-off and Intel's move to maintain its 2001 capital
equipment spending at $7.5 billion.
Cisco's inventory write-off means excess
communications chips won't be lying around for long.
Intel's commitment to invest in advanced processing
technology means companies like Applied Materials
(Nasdaq: AMAT) will continue to gain.
"We believe that while the current downturn is likely to
last for some time to come, the news from Intel and
Cisco are early indications that the downturn could be
shorter," said Robertson Stephens analyst Sue Billat.
She said Applied and Novellus Systems (Nasdaq:
NVLS) are among the companies to emerge from a
downturn stronger. |
