From Canadian Business Magazine:
The shock of the old
An Old Economy, low-return company lurks beneath Celestica?s flashy exterior.
By Sean Silcoff | May 1, 2000
Gerry Schwartz has done a great job with Celestica. Four years ago, it was a sleepy, underappreciated IBM subsidiary that made electronic components. Then Schwartz?s Onex Corp. bought the company for $750 million and launched it on an acquisition spree before taking it public in 1998. Now Celestica is a favorite of analysts and investors alike. It?s no wonder. Since its IPO, the company, headed by CEO Eugene Polistuk, has posted the sort of spectacular returns you?ve come to expect from a high-tech darling.
But that?s where the similarities end, because Celestica has a lot more in common with boring Old Economy companies than highfliers that offer the unlimited potential of an Internet start-up or the fat profits of a software producer.
Electronics components manufacturing (ECM) is a rather mundane business with razor-thin returns. In order to survive, Celestica must buy smaller competitors or hustle outsourcing contracts from Nortel Networks or Lucent Technologies. It?s a game Celestica appears to be winning. It is now the world?s third-largest ECM. Its revenue has soared from $2 billion in 1997 to $5.3 billion last year.
That?s impressive. Unfortunately, it?s difficult to find out exactly how much of that growth is merely the result of Celestica?s buying spree (which has been funded by three stock issues since the IPO) or from new business. The company claims two-thirds of its sales growth is internal, but one New York hedge fund manager has serious doubts. In order to get around the problem, he runs a little test by tracking Celestica?s revenue per shares outstanding. His findings: over the past three years, Celestica?s revenue per share has grown a mere 8%?barely keeping pace with the overall growth of the electronics sector. Meanwhile, Celestica?s gross profit margin of 7.2% has barely budged from its 1997 level, and the company?s returns on equity and assets, though improving, lag those of its three largest competitors. "It?s a pretty crappy business," says the hedge fund manager, who holds a short position against Celestica. "The numbers do not justify the market valuation."
Another big question concerns the company?s earnings. Celestica instructs analysts to ignore its net earnings and focus instead on a far more impressive figure: its "adjusted net earnings," which don?t take into account amortization of intangible assets or acquisition-related integration costs. Management argues this puts the company on an equal footing with its US competitors, which don?t have to write down goodwill on acquired assets. But Celestica manages to squeeze an awful lot into its integration costs, including marketing and salaries, which should be pretty standard operating costs?and therefore expenses on the income statement.
Another boost to earnings has come courtesy of Celestica?s success with new offerings in the public markets. As cash rolled in, the company paid off debt, ratcheting down interest expenses from $32.3 million in 1998 to just $10.7 million last year. That translated, by the hedge fund manager?s estimation, into a boost of about 13½ per share to the bottom line?or a full 40% of the company?s 1999 growth in after-tax adjusted earnings.
Celestica has issued a stunning $1.9 billion worth of stock in the past year alone, and will probably raise the same amount in the next 12 months. But Celestica and its competitors are playing a pretty dicey game. The whole outsourcing trend is driven by the ability of consolidators to raise money by selling expensive equity?and Celestica?s is the most expensive. But if unstable markets make it difficult for Celestica to market new issues?or to do so at its current high multiples?its earnings picture will start to look even less impressive. Besides, it can be only a matter of time before investors realize the ECM market just doesn?t offer the same kind of quality long-term growth potential as other, genuine high-tech industries. One industry expert expects the outsourcing trend to expire in another two years or so. "This cycle will be short-lived and come to an end," he says. "Then this whole segment will fall out of favor." If so, it might be a good time to start thinking about selling Celestica.
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