From the latest issue of Fortune:
Blessed Are the Piece Makers
No guts, no glory? To heck with that! When it comes to high tech, you can buy the guts and get the glory too. Here are five safer growth stocks to play now.
Ahmad Diba
Flextronics
FLEX 49.2 $2.0 488% Revenues should double next year with major acquisition of DII Group.
Celestica
CLS
(IPO in 6/98) 47.8 $5.3 439% Dominates the workstations market; Sun Microsystems alone accounts for 20% of sales.
Jabil
JBL 41.9 $2.3 435% Determined to expand globally with new facilities in Brazil, Hungary, and China.
Solectron
SLR 48.4 $8.4 385% Best positioned to grab share in the $100 billion-plus repair-services market.
SCI Systems
SCI 35.6 $6.7 203% Finally plunged into telecom with last year's major factory purchase from Nortel.
Volatility doesn't even come close. It's a polite, almost genteel sort of notion--as though the stock market were going through a bit of in-flight turbulence. Hell, what we've just witnessed in the Nasdaq is a Stone Cold Steve Austin rope-catapulting slamdown. The floor shook. What's left of it anyway.
So where does that leave you? Dizzy, shell-shocked, swearing on your mother's IRA that you'll never dance in the tech market again? Well, you don't have to go that far. In fact, you may be able to profit from this explosive high-growth sector and take the risk factor down a notch in the process. Think of it as the ultimate tech guts play--since the trick here is to buy the guts of all those new-economy essentials like digital phones, network routers, PCs, PDAs, and other newfangled gadgetry. And by guts, of course, we mean the electronic hardware inside, from wires to widgets, from speakers to circuitry.
Many of the companies that make these low-voltage nuts and bolts have been generating unimaginable gains for years while miraculously remaining below the buzz meter. Left alone, a $10,000 investment in Microsoft bought on Jan. 1, 1990, for example, would be worth some $650,000 today. But that's just a fraction of what you'd have earned with an equal investment in Solectron--a lowly contract electronics manufacturer that IPO'd in December 1989. That kind of prescience would have landed you a $1.8 million nest egg--an 18,000% gain. Nor do things seem to be slowing down. Though the Nasdaq is off (at FORTUNE's closing time) some 34% from its high in early March, Solectron has been drinking at another party. It's up more than 5%.
Indeed, Solectron, along with more recent competitors such as Celestica, Flextronics, Jabil, and SCI Systems, still dominates the electronic-manufacturing-services (EMS) industry. Today, these EMS providers do the grunt assembly work for so-called original-equipment manufacturers like IBM, Lucent, and Sony. (Yes, that makes these name-brand guys neither original nor even equipment makers, per se.) The concept is surprisingly simple. Motorola will hire, for example, SCI Systems to build its cell phones. SCI then contacts its suppliers for parts ranging from speakers to casings to that weird little doodad that makes your phone vibrate. These components all go in one end of a huge factory, and then massive quantities of phones come out the other. Of course, some customers only outsource parts of their products--as Dell Computer, for instance, does with its motherboards--and some EMS providers build their own components, such as printed circuitboards. But by and large, as Deutsche Banc Alex.Brown's Michael Carboy describes it, the EMS firms act like an orchestra playing some big-name composer's symphony.
The formula is hardly new. Since the turn of the century, GM has outsourced some of its car components. Now the titans of tech have come to the same conclusion. One example is Cisco Systems, where executive VP Carl Redfield believes his company has saved $900 million to $1.3 billion by outsourcing more than half the manufacturing of its routers and such.
With big shots like Sun Microsystems following Cisco's lead, and newcomer networking companies like Juniper and Sycamore outsourcing practically everything these days, the EMS sector has seen sales literally multiply. Since 1990, Solectron's revenues have skyrocketed from $205 million to an expected $14 billion this year. Likewise, San Jose, Calif., firm Flextronics is expected to pull in some $5 billion in revenue this year; in 1995, the figure was $237 million. And others have enjoyed comparable growth. Not surprisingly, their success has been well rewarded by Wall Street. Last year Celestica, a Toronto firm, led the group, with its share price shooting up 350% from the year before. Even the worst performer, SCI Systems, still managed a respectable 42% gain. But it's over the longer term that you see the most mind-boggling numbers. For the past five years these stocks (not counting Celestica, which IPO'd in '98) have returned a cumulative 2,316% on average--a number that beats the Nasdaq silly.
The natural next question is: Have these companies already seen the lion's share of their growth potential? Surprisingly, the answer seems to be: Not even close. One of the more clever recent twists in the game is that these electronics assembly firms have made a practice of acquiring their customers' factories in order to get the business that goes with them. In March, for example, Solectron laid out $900 million for several Nortel facilities in a deal expected to add at least $10 billion in production-contract revenues over the next four years.
The CEOs of the top five EMS providers say they have captured at most 20% of the potential outsourcing market. (The total electronic-goods market is valued by Technology Forecasters, an Alameda, Calif., research firm, at more than $600 billion worldwide--a number expected to grow by 22% a year through 2003.) "A single percentage point of penetration is worth about $6 billion," says Tim Main, Jabil's president. Analysts from Merrill Lynch to Thomas Weisel to Chase H&Q believe that the group's market share will grow by some five to 10 percentage points within four years. As it is, the electronics industry as a whole is growing at three to four times GDP.
Apart from the growth, another factor seems to make these particular tech players safer bets than many of their customers--these worker bees don't depend on any one queen-bee product or even industry. Flextronics, to take one example, can build Nokia phones right next to Motorola's and Ericsson's; if one line slows or evaporates, the company can often make up for the lapse with other production lines--or, as is increasingly the case, with service-contract repair work or product upgrades. Analysts estimate that "after-purchase repair market" at about $100 billion or more a year.
Jerry Labowitz of Merrill Lynch estimates that Celestica, Flextronics, Jabil, SCI Systems, and Solectron will together see revenues grow about 50% this year. (Other analysts predict that rate will stay in the 40-55% range for at least the next four years.) Solectron, for one, says it plans to jump from its $8.4 billion in 1999 revenues to $20 billion by 2001. Few analysts seem to be laughing.
That's not to say the stocks are worry-free. One drawback to the sector is short-term volatility. On a month-to-month basis, the stock lines for these companies tend to spike up and down like an EKG. Because they operate on margins not much better than your average Wal-Mart's, electronics assembly firms work at breakneck speeds to keep up with an insatiable demand coming from half a dozen different industries. Sudden, even short-lived production glitches have often meant swift reaction in the stock market--as Solectron learned last December when it announced a component supply problem.
So strict bottom-line efficiency in these firms has become a cultural necessity. Solectron CEO Koichi Nishimura, the personification of the sector, it would seem, drives a '94 Honda and owns only white shirts, dark-gray suits, and matching socks so he can dress faster in the morning. (This is a FORTUNE 500 company, mind you.)
With all the talk of growth, though, you'd almost forget the key factor that sets these companies apart from the new-economy wunderkinds: The five majors all--yes, all--have positive earnings. And the analyst consensus is that those earnings will grow on average about 35% a year through 2001. Says tech analyst J. Keith Dunne of Robertson Stephens: "It's the only industry we can identify that is growing as fast as the Internet, and still making money."
So which one to buy? Because these five companies are so similar in fundamentals, the best strategy may be just to buy the whole basket. Flextronics may have better global footing, while Solectron still stands as the market leader--but in the end, as Celestica CEO Eugene Polistuk believes, "This is an industry where not only one of us will win. I honestly believe all five of us will win." When was the last time you heard a CEO say that? |
