Thanks Mike, a bit more on FLEX and the contract manufacturers from the 5-22 issue of Barron's
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MAY 22, 2000
What's Contract Manufacturers' Best Product? Black Ink
By MARK VEVERKA
With the Federal Reserve and the Department of Justice seemingly doing a tag-team number on the Nasdaq, tech investors continue to stay on the sidelines wondering whether they've hit bottom or the floor will give way to yet another 1,000-or-so-point tumble.
But not all the news was glum. The red-hot contract-manufacturer market continues to boom while its shares suffer from much of the same malaise that besets Silicon Valley. Case in point: At their annual analyst meeting in New York last week, Flextronics International executives continued to paint a positive picture for their company, which many contract-manufacturing fans think is the pick of the litter.
Paul Meeks, senior manager of the Merrill Lynch Global Technology Fund and an attendee at the Flextronics confab, says the company has identified yet another area for expansion. Company officials indicated that not only can they make a ton of dough by building high-quality gear to precise specification for the likes of Cisco Systems and Ericsson, it also may someday start installing the stuff too.
Over the next couple of years, Flextronics thinks it can rack up another $1 billion in revenues from installing equipment for original-equipment makers, mostly in the telecom segment. Another positive nugget disclosed at the Flextronics meeting was a plan by German industrial giant Siemens, which traditionally makes most of its own gear, to join the outsourcing fray, spurring even more growth in this already torrid segment.
For its part, Flextronics remains one of the fastest-growing companies in this bunch. It has vaulted from being a third tier player with $131 million in revenues in 1994 to big dog; this year's sales will flirt with $9 billion, estimates analyst Jerry Labowitz of Merrill Lynch. Labowitz, who rates the stock a buy, has a $90 price target, assuming it trades at 47 times projected 2001 earnings of $1.92 a share. The stock closed Friday at 51 3/16.
We have chronicled Meeks' enthusiasm for this segment before. He has been an unabashed fan of contract manufacturing for some time. And for the most part, his vision for this group is holding true. His primary premise? Major global makers of telecom gear will continue to outsource more and more of their production because it is cheaper and more efficient, fueling the growth of their outsource clients.
What's more, these companies boast historical top-line growth of more than 30%, and those rates are expected to crank up to more than 50% a year -- at some companies, upwards of 100% a year. Their long-term contracts provide relatively clear visibility, the companies are hugely profitable at a time when black ink is in vogue, and they are trading at a discount to growth. In short, they are booming businesses with fundamentally sound financials. Heavens, profits and revenue growth! What's a self-respecting tech speculator to do?
"All of the [original-equipment makers] have long taken note that one of the reasons Cisco has been so successful is that it had essentially pioneered this virtual business model" that stresses the outsourcing of production, Meeks says.
As many a tech-fund manager moped around the recent Chase H&Q stock conference at San Francisco's St. Francis Hotel, one of the most avidly supported ideas for the current tech slump was the contract-manufacturing group. Hence, we looked up Meeks and glanced at his report card.
Since June 1, which is shortly before we last featured Meeks in this column, the unweighted value of the contract-equipment manufacturers that he holds had risen about 80%. That compares with a 12% increase for the S&P 500 and a 1.6% jump for the Dow Jones Industrials for the same period.
His favorite name in this category, if you haven't already guessed, is Flextronics, which is up a 121% for the same time frame. Jabil Circuit jumped about 59%, while Celestica soared about 125%. In the meantime, shares of Solectron, the 800-pound gorilla in this category, climbed about 32%, and Sanmina rose about 62%.
Naturally, like most Nasdaq stocks, this group has taken a hit since the tech market began to crater in March. As of March 10, Flextronics' shares have tumbled about 25%, Jabil is down about 15%, Celestica is down about 15%, Solectron has been trimmed by about 4% and Sanmina shares have fallen about 9%.
On average, Meeks' stocks have suffered an unweighted haircut of about 14%. Meanwhile, the S&P is up about 4% since March 10 and the Dow has gained about 9%.
Meeks is confident that revenues are going to soar and that sell-side analysts have been low-balled by management. "I think the models are pretty conservative, except for Selectron," he says.
Solectron made a pre-announcement earlier this year that it would miss its numbers. "They gave investor guidance that was too bullish, which was an investor-relations faux pas," Meeks says. Essentially, Solectron officials expected to realize revenues from acquisitions that didn't close on time, he says. Despite the stumble, "even that company should still be absolutely dynamite over time," he insists.
Adding fuel to the fire, the fund manager also expects that Celestica will unveil some big contract wins in the near future, and that Lucent Technologies will announce another tranch of contracts that will increase business for his favorite companies.
Joining Meeks in his affection for the sector is Jim Savage, a financial analyst with Thomas Weisel Partners. Savage last week released a bullish report on contract manufacturers, calling their recent selloff a buying opportunity.
Savage says Selectron's earnings miss combined with the general tech wreck had wrung about 28% in value from contract manufacturers' shares since the beginning of April. "The Selectron news in particular spooked some people," Savage says.
He attributes Selectron's woes to its dependence on making cell phones, which is a slim-margin business. Investors first became skittish on this group because it was beholden to personal-computer makers, such as Dell Computer, and their skimpy margins. But a shift toward telecom gear has brought mostly fatter margins, with the exception of making the phones themselves, Savage notes.
"It's continuing to be an issue for Selectron because a large percentage of their business is from cell phones," he says, adding that Solectron's dependence on cell-phone outsourcing swelled to 16% in February from 12% in November.
Of course, there are risks. And with this group, there are two major concerns. First, there continues to be a component shortage for certain telecommunications parts, but Savage contends that big contract manufacturers will be able to manage their way though shortages because of their volume purchasing power and the might of their clients: Cisco, Lucent, Nortel, Motorola and others.
The other fly in the ointment is consolidation. Big contract manufacturers are expanding their capacity through buyouts. And if they fail to integrate these acquisitions smoothly, the mistakes will hurt revenue and earnings performance. But, thus far, Savage isn't sweating it. "Generally, the contract manufacturers have been meeting and beating their numbers and we don't see that changing," Savage says. |
