EMS providers seek higher valuations from Wall Street
By ADAM PICK, ISUPPLI CORP.
May 19, 2005
emsnow.com
Companies attempt to boost margins and market values through design services
Many of the top Electronic Manufacturing Services (EMS) providers are reorienting themselves toward the design-services business in order to achieve higher margins - but is Wall Street rewarding these companies by boosting their market valuations?
Recently, five of the top seven EMS providers have embarked on strategic shifts in order to offer new services, specifically system and sub-assembly design. In pursuit of these capabilities, there has been a flurry of mergers, acquisitions and partnering among the EMS providers.
Top executives at EMS companies expect these moves to boost their competitive position, their profitability - and their stock prices. However, a review of financial firms' ratings and a discussion with a key financial analyst shows that attaining the desired valuation increases can be difficult - and sometimes hard to understand for even the sharpest of EMS executives.
Making the grade
To gauge the views of the financial community, iSuppli in April charted the equity ratings of the top EMS providers using data provided by First Call/Thompson. As presented in the Figure, the financial community's views of the EMS industry were ranked on a single axis spanning the gamut of opinion from "strong buy" to "sell."
Figure: First Call/Thompson Rankings for Select EMS Equities
Source: First Call/Thompson
As iSuppli assembled this data, we were curious to know whether the possibility of higher margins from design activities would elevate the valuations of the EMS providers.
Jabil benefits from stealth
Jabil Circuit Inc., which has developed a cult-like following for its approach to managing its strategic discipline of "operational excellence," was ranked the highest EMS provider by First Call/Thompson. Unlike several of its competitors, Jabil has remained rather stealthy about its design offerings. In fact, Jabil only recently has begun revealing its design strategy to the analyst community.
According to a recent iSuppli interview with Philip Kennedy, Jabil's director of business development for the Americas, the company has created a standalone division internally known as Jabil Technology Services (JTS). JTS is responsible primarily for collaborative design initiatives in which Jabil works with its OEM customers to co-develop products such as displays.
"We're not going to burn our OEMs like some of the ODMs (Original Design Manufacturers) out of Taiwan," Kennedy said.
Flex Struggles for Recognition
In contrast to Jabil's stealthy approach, Flextronics' design-centric merger and acquisition activities have been a matter of public record. Despite this, the company has failed to generate higher analyst equity ratings and improved stock valuations. This has been a matter of confusion for Michael Marks, the highly-respected chief executive officer of Flextronics.
"Sometimes I just don't understand how the financial guys value our stock relative to our peers," Marks has commented more than once.
On April 28, Marks announced that - in an effort to further increase shareholder value - Flextronics' board of directors was in the process of planning a share buy-back program as well as other divestiture schemes. Since then, Flextronics' has announced the sales of its network services and semiconductor divisions. The impact? Company stock has increased by 18 percent since April 28.
Solectron brings up the rear
Solectron has slid from the number-one EMS revenue ranking in 2001 to the number-four position in 2004, according to iSuppli's market-share data. In parallel, the company has seen its future outlook and equity rating slashed by several investment firms. Today, Solectron has the lowest-ranked equity among the top EMS surveyed in this analysis.
Since December, 2004, after failing to follow through on its turnaround initiatives, Solectron's stock has been downgraded by Robert W. Baird, Raymond James, KeyBanc Capital Markets and Bear Stearns.
Inside the mind of a Stock Analyst
To shed light on how Wall Street arrives at its opinions on the various EMS firms, iSuppli this month interviewed Amit Daryanani, vice president, EMS research for RBC Capital Markets.
"In such an environment - high volatility of orders coupled with tepid end-markets - investors ought to play defense by looking at companies that have had and will have strong execution going forward," Daryanani said. "Two EMS companies meet that criteria: Benchmark and Jabil. They both have excellent customer penetration and worked hard in entrenching themselves with the OEMs over the last several years."
Daryanani added that there is a premium placed on companies whose growth is not so dependent on the expansion of end markets.
"If one analyzes the tech hardware landscape it is rather difficult to find companies that can grow more than 10 percent without any end-market growth," Daryanani said. "In such an environment we believe names like Jabil and Benchmark are highly desirable given their ability to grow without any growth in underlying end-markets."
Taking Stock
What can EMS companies learn from Daryanani's comments and their various stock valuations?
For one, Wall Street considers maintaining good customer relations and diversification to be more important than having a bold vision for design services.
Both Jabil and Flextronics are pursuing design-centric strategies. When using such strategies, the EMS companies risk encroaching on the territory of customers that have traditionally performed their own design work, thus alienating them. This has often been a criticism of the ODMs, such as BenQ.
By keeping its strategy largely under wraps, and by working with customers to take a collaborative approach to design, Jabil has managed to maintain its key relationships and operational discipline intact. Meanwhile, Flextronics' more open approach to its design services has raised concerns, and perhaps some skepticism, among the financial community.
Furthermore, Wall Street appears to place more value on EMS providers that have a track record of industry-beating growth and profits amid weak demand than on those that promise bold restructurings that will boost future profitability.
Finally, results trump everything. Companies that don't bring home the bacon and fail to execute will pay for it through poor equity ratings and depressed stock prices, regardless of their glorious past or promises of a brighter future.
Adam Pick is the senior analyst in the EMS/ODM Market Intelligence Service at the market intelligence firm iSuppli Corp, El Segundo, Calif. Contact him at apick@isuppli.com |
