Flextronics Quietly Builds Electronics, and Value
February 22, 9:35 am Eastern Time
worldlyinvestor.com Sector of the Day
By Robert Cyran, Correspondent
Flextronics makes the guts of your electronics. Works well in a portfolio too.
If you are foolish enough to pry open your Palm Pilot, thus voiding the warranty, you would find that a company called Flextronics (Nasdaq:FLEX - news) made most of the parts.
In fact, a little exploratory surgery would show that this global electronics dynamo makes the guts of many of your electronic goods. The company is so pervasive in such a hot marketplace that many analysts suggest also placing some of its stock in your portfolio.
The day is long gone when high-tech companies such as Cisco (Nasdaq:CSCO - news), Ericsson (Nasdaq:ERICY - news), and Philips Electronics (NYSE:PHG - news) actually made the goods that bear their names. Now, these firms want to concentrate on the high-margin tasks of design, research and branding.
Ruling the Lower Margins
Flextronics is one of the fastest-growing of a new breed of companies called Electronics Manufacturing Services (EMS), which are taking over the messy business of making things from the companies that develop and brand them. Flextronics and its larger competitors, Celestica (NYSE:CLS - news) and Solectron (NYSE:SLR - news), don't mind the lower margins of manufacturing because they do so much of it.
Flextronics stock may seem a little rich, trading at 73 times its earnings after adjusting for acquisitions in 1999. But keep in mind that earnings are expected to grow 66% this fiscal year and 50% next year.
Furthermore, Flextronics has a habit of beating estimates regularly. As a result, Flextronics' shares have tripled over the past 12 months.
The total market for electronics outsourcing for 1999 was about $72 billion, according to Technology Forecasters, a market-research firm. About 4% of that was performed by Flextronics.
The market for electronics manufacturing is global, and so are the outsourcers. Flextronics' corporate structure reflects this internationalism. Its headquarters are in Singapore, although most operations are run out of its Silicon Valley center.
Bordering on Rich Markets
If you want to find a Flextronics factory, just look around the borders of rich regions throughout the world. Flextronics plants in Hungary, Mexico and Malaysia are filled with cheap, skilled labor adjacent to the rich markets in the US, Europe and Japan.
These factories can take orders electronically and begin shipping the order as fast as they can make it. Often, this is much faster than the designing firm could set up a production line.
Specialization in manufacturing brings other benefits. Flextronics drives down construction costs by applying the lessons learned from previous production runs. In addition, factory equipment can be run continuously. If orders for Ericsson slow down, the line can be quickly switched to produce Nokia equipment
Can't Add Capacity Fast Enough
Flextronics has made over a dozen acquisitions in the past three years. Manufacturers such as Ericsson, ABB and Fujitsu (OTC:FJTSY - news) sold factories in exchange for cash and an outsourcing contract. Flextronics bought the factories and raised productivity by producing components for several companies.
Flextronics has also been snapping up other outsourcing companies. Its largest action to date has been its proposed merger with DII Group (Nasdaq:DIIG - news) which is expected to close in April.
Despite adding on so much capacity, Flextronics still has to turn away customers.
''Flextronics couldn't begin to handle all the demand it had in China,'' says Sasmit Dwivedi who covers Flextronics for CIBC, an investment bank. ''The DII merger should help because they can send some of these orders to DII's Asian factories.''
Small but Efficient
With all of Flextronics acquisitions in the past several years, is Flextronics buying its growth? Not at all. According to analysts, Flextronics has the highest rate of internal growth in the EMS business.
''Flextronics' revenues grew a little over 100% in the most recent quarter and nearly all of that was organic growth,'' according to Shelby Fleck of Morgan Stanley Dean Witter.
Revenues are increasing at such a rapid rate because the majority of Flextronics' contracts are for high-growth areas, such as data-networking and telecom equipment. Analysts conservatively expect Flextronics to grow at least twice the speed of the overall electronic-outsourcing market, which doubles every three and a half years.
Earnings haven't been stagnant either, growing at an average annual rate of 54% from 1995 to 1999. This was higher than the 50% growth rate of Flextronics' competitors.
Although Flextronics is one of the largest outsourcers, last year's $3 billion in sales are muscled aside by outsourcing giants Solectron, with $8.4 billion, and Celestica, with $5.3 billion.
But what Flextronics lacks in size it makes up in efficiency. Fleck says that Flextronics spends the least on management of all the outsourcers. This is impressive considering she thinks it has the fastest rate of internal growth. Efficiency should continue to rise as the company grows and receives bigger discounts from its suppliers.
Outsourcing Still in Growth Stage
Outsourcing is in no danger of slowing down.
Companies haven't come close to divesting all the factories they run. Japan, in particular, offers tremendous room for growth, given that Japan's huge electronics-manufacturing concerns have just begun to look at outsourcing.
Besides geographic expansion, outsourcers are expanding the range of services they offer by moving into the more lucrative fields of engineering and supply-chain management. The ultimate goal is rather breathtaking -- they want to handle all physical activities of their clients, leaving them free to focus purely on design and branding.
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