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Monday June 5, 5:00 pm Eastern Time
Individual Investor
Computer: Motorola Deal Sparks Tech Outsourcers
Research Analyst: Hal Levey (06/05/00)
Remember when contract electronics manufacturing (CEM) companies saw their shares slip last month amid worries over component shortages? No? You're not alone: Investors seem to have forgotten their anxieties as well - and with good reason.
Many CEM companies have seen quite a run up in share prices recently. It should come as little surprise that the rally is pegged to the biggest deal the nascent industry has seen to date. That deal, and several smaller ones, bode well for the future of these outsourcing companies.
Last week, Motorola Inc. (NYSE: MOT - news) said it would outsource more than $30 billion of its consumer electronics production over the next five years to Flextronics International Ltd. (NYSE: FLEX - news).
In 2005, the final year of the deal, Flextronics will make more than $10 billion worth of components used in Motorola's wireless phone, two-way pager and infrastructure businesses. The deal represents about 15% of Motorola's communications enterprise manufacturing over the five-year period.
As part of the alliance, Motorola will pay approximately $100 million for an equity instrument convertible over time into 11 million shares of Flextronics stock.
Shares of CEM companies have been flying higher in the wake of last Thursday's announcement, as evidenced by some heady gains seen that day. Flextronics jumped $8.43 to $62.88. Jabil Circuits (NYSE: JBL - news) gained $4.13 to $40.63, while Sanmina Corp. (NASDAQ: SANM - news) rose $5.31 to $68.94.
Plexus Corp. (NASDAQ: PLX - news), a smaller player in the field, sprinted $6.13 to $89.63. Other gains were muted in comparison, as SCI Systems (NYSE: SCI - news)finished changing hands at $48.06, up $3.06 and Celestica Corp. (NYSE: CLS - news) was $1.44 higher at an even $48.
We spotlighted Flextronics, and its many industry peers in a recent story.
Back then, we noted that contract manufacturing companies had been seeing such strong demand for their services that CEMs were having trouble getting enough components to satisfy orders. We also wrote that the CEM market offered investors a respite from the volatility of tech stocks, while still giving them the chance to latch on to rocketing valuations.
Components are still scarce, and as Thursday's results show, shares are still on the rise. The Flextronics/Motorola deal offers the latest and largest demarcation point in the ever-evolving relationship between CEMs and their customers.
The pact offers ``another data point showing that outsourcing is a proven model,'' says Taimur Dawood, an equity associate at UBS Warburg, and Motorola is the latest company to signify its commitment to this model.
The trend toward outsourcing is indeed accelerating, as is the pace of consolidation among smaller CEM players. In April, Sanmina agreed to buy Hadco Corp. (NYSE: HDC - news) in a $1.3 billion deal in order to add production capacity and boost circuit board sales.
Solectron (NYSE: SLR - news) bought assets from Nortel Networks for $900 million, and entered into a $10 billion outsourcing agreement with the company. And companies including Ericsson (NASDAQ: ERICY - news) , Lucent Technologies (NYSE: LU - news) and Alcatel (NYSE: ALA - news) recently said they would expand relationships with contract partners.
Even against that backdrop, there's a huge and untapped market for outsourcing companies. David T. Parrish, a Dain Rauscher Wessels analyst, says only 15% of the market -- which the analyst estimates stands at nearly $700 billion worldwide -- was handled by contract manufacturers in 1999.
The Flextronics/Motorola pact ``says that the market is bigger than anyone had imagined,'' according to Thomas Weisel Partners analyst James Savage. The analyst says he had forecasted that the overall revenue growth rate among the top CEM players would be around 50% over the next two years - but in light of the recent high-profile deals, those CEMs could reach that number as quickly as next year.
As the well-documented component shortage has shown, demand has far outstripped supply. Dain Rauscher's Parrish says the shortage is not improving, at least for the moment, and adds that general expectations are that there won't be much improvement until next year. Thomas Weisel's Savage also says the component issues will most likely not see a resolution until sometime in 2001.
In such a market, the top tier CEMs will fare well because they have strong relationships with suppliers. Second tier players will have to rely on the strength of their material procurement teams and third tier companies may have a more difficult time securing components, Parrish contends.
The component shortage is unlikely to have an impact on Flextronics, predicts Savage, as any additional work for the company stemming from the agreement with Motorola will likely not begin until the beginning of calendar year 2001. And, he adds, the integration issues between the two companies present a ``very big task ... I don't think Flextronics or Motorola will want to rush into this and not make it work.''
One consequence of the Flextronics/Motorola pact - beyond the recent upswings in share prices - could be that second-tier CEMs could see a marked increase attention from possible OEM partners.
Savage says that in the wake of this week's announcement, OEMs, especially mid-sized companies, will want to move quickly to solidify long-term relationships with CEMs. However, as the larger players in the CEM arena will be focused on their own, multi-billion-dollar agreements, management attention might be spread pretty thinly.
As a result, Savage says, OEMs might gravitate toward setting up relationships with some of the ``capable peers'' of Flextronics, Solectron and Sanmina.
Bottom Line:
Look for stock prices to continue rising in this sector amid strong demand, growing opportunities for outsourcing, and as OEMs look to lock-up long term deals with capable suppliers.
For more in-house professional stock analysis and commentary, visit us at Individual Investor Online.
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More Quotes
and News: Alcatel (NYSE:ALA - news)
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Ericsson, Telefonab. L M AB (NasdaqNM:ERICY - news)
Flextronics International Ltd (NasdaqNM:FLEX - news)
Hadco Corp (NYSE:HDC - news)
Jabil Circuit Inc (NYSE:JBL - news)
Lucent Technologies Inc (NYSE:LU - news)
Motorola Inc (NYSE:MOT - news)
Plains Resources Inc (AMEX:PLX - news)
Sanmina Corp (NasdaqNM:SANM - news)
SCI Systems Inc (NYSE:SCI - news)
Solectron Corp (Delware) (NYSE:SLR - news)
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