EMS providers setting tough terms for OEMs
OEMs must meet volume targets, provide more cash reserves
Claire Serant / EBN / (10/29/2002 1:05 PM EST)
Cash-strapped contractors are putting pressure on OEMs that want to divest plants as part of hefty outsourcing deals to meet quarterly fixed-volume targets and provide more cash reserves upfront. If not, they won't accept the contract.
The new terms are being enforced for two key reasons. Some billion-dollar deals EMS companies secured from major OEMs over the past two years are worth less than half of their original value today because of the continuing economic malaise, analysts said. And taking on the fixed cost of an OEM's plant is too risky.
"Two years ago, EMS providers took the risk [to acquire an OEM plant] because they didn't think business would decline and figured that new customers would be brought to those sites," said Randy Furr, president of Sanmina-SCI Corp., San Jose. "We inherited the fixed costs of those sites. Because demand is slow and there is plenty of [manufacturing] capacity, those plants ended up being a loss because we couldn't adjust the price to the customer."
EMS providers are now setting limits on the amount of equipment and plants and the number of employees they are willing to inherit from OEMs. Stronger contracts are viewed as the glue that protects EMS companies' lean margins, which are typically in the range of 3% to 5%.
"New deals involve a lot of protection [for EMS providers]," said Shawn Severson, an analyst at Raymond James & Associates Inc., St. Petersburg, Fla. "If you take on an OEM's location, you must get minimum-volume requirements or you have to close the plant."
An OEM's viewpoint
But not everyone is pleased with the new EMS push. "We're interested in long-term relationships [with EMS providers], not one that has borders for minimum- or maximum-volume agreements," said a spokeswoman for Lucent Technologies Inc., Murray Hill, N.J.
Last week, Solectron Corp., Milpitas, Calif., became the latest major EMS company to exit an unprofitable pact. Solectron and Lucent unraveled a May agreement for Solectron to make optical networking products under a three-year contract valued at $2 billion. Solectron agreed to lease a portion of the telecom equipment maker's Merrimack Valley, Mass., plant. The EMS provider paid $99 million in cash for certain manufacturing assets and kept on 540 Lucent employees.
"Solectron generated sales of $50 million in the August quarter from the transaction as demand deteriorated," said Jerry Labowitz, an analyst at Merrill Lynch & Co. Inc., New York, in a report. "It's unclear if Lucent will totally sever its ties with Solectron, however if this were to occur, it should not have a material financial impact on the EMS company."
Solectron will be reimbursed for a portion of the $99 million, but the payment will exclude the inventory used in production and any depreciation on the acquired equipment, Labowitz noted.
"It was a good step for our business and is an example of our commitment to take on business that we can serve well at a reasonable profit for our company," said a Solectron spokesman. "Both parties agreed to unwind the situation. Solectron is coming out of this situation whole."
Other criteria
Solectron and Lucent are not alone in their struggle. To win better contracts, some EMS providers are pricing their deals based on the length of the project and the overall volume picture, said Mark Zetter, president of Mark Zetter/Outsource Manufacturing Strategic Consulting, San Jose.
"For example, an EMS company can agree to build a product for an OEM for two years at a price of $1 per unit," Zetter said. "However, if the relationship is only for one year, then the price becomes $1.15, which equals a 15% unit price increase."
In some cases, contractors require their customers to have cash reserves on hand of at least 12 months before accepting product orders, which is difficult for start-up OEMs.
EMS companies are also considering their customers' overall financial position and the health of a product's market before they sign on the dotted line.
Last year, Jabil Circuit Inc. agreed to purchase five plants from British telecom equipment maker Marconi plc for $390 million. In turn, the St. Petersburg, Fla., EMS provider would be given a three-year outsourcing contract valued at $4 billion--the largest deal in Jabil's history. However, as market conditions for communications infrastructure products declined, so did the value of Marconi's contract.
By January, Marconi's financial woes caused it to lay off 4,000 workers. Jabil then proceeded in the spring to close the Liverpool, England, plant formerly owned by Marconi. But Jabil sidestepped any charges by having Marconi assume between $25 million and $28 million in consolidation and head-count reduction costs. That contract provision helped Jabil avoid financial burdens, industry observers said.
This summer, Sanmina-SCI and German telecom equipment maker Siemens A.G. agreed not to proceed with plant divestiture plans. Siemens wanted to sell three plants from its Information and Communication Networks division. The accord would have given Sanmina-SCI two IC network operations in Europe and a final- systems-assembly operation in Lake Mary, Fla. But the deal never materialized. Siemens was not comfortable with Sanmina-SCI's contractual terms, according to industry observers.
"We mutually decided not to go forward," said Sanmina-SCI's Furr, citing a nondisclosure agreement with Siemens that prevents him from discussing details of the companies' proposed transaction. |
