Tim,
An interresting article in Briefing that examines the Asian crisis and the impact on companies. including ASND. A thoughtful analysis amidst the hysteria.
Mark.
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Asian Exaggeration
Daily commentary updated for October 31, 1997
Simple But Wrong
As goes Southeast Asia, so goes the tech sector. At least that's the way it's been since late last week. Expectations of a sharp deterioration in Asian economies have prompted fears of a slowdown in the earnings growth of tech companies which have significant sales in the region. The attraction of this argument lies in its simplicity: tech firms export to Asia; Asian economies slow, tech exports to Asia fall. But it's not that simple, and fortunately for tech companies, the news is not nearly as bad as the market now suspects.
Where's the End User?
The problem with the aforementioned argument stems from one mistaken assumption: that the exports of tech goods to the Southeast Asian region are destined for end users in that region. If that were the case, the loss in purchasing power of the Asian currencies and the near certain slowdown in Asian economic growth would indeed lead to slower growth or even outright declines in tech exports to the region. But that is not the case.
Tech exports to SE Asia are predominantly capital and intermediate goods used in the production process of final goods which are then exported out of SE Asia. Plain English: when Intel exports a Pentium II 266 to Korea, it is not destined for the average Korean citizen. It is destined for a box builder which will be exporting PCs primarily outside of SE Asia. The key factor determining demand for Intel's products is therefore not the state of the domestic Korean demand, but the state of demand for Korean exports.
Inside the Numbers
Our point can be made more forcefully with a look at the numbers on US trade with SE Asia. For the first seven months of 1997, US exports of electrical machinery and equipment (a broad category which includes most high tech products) totalled $36.9 bln. Of this total, 50.4% or $18.6 bln, was destined for eight countries in SE Asia which have been hit hardest by recent financial crises: Hong Kong, Indonesia, Malaysia, Philippines, Singapore, South Korea, Taiwan, and Thailand. Common sense dictates that half of our tech exports are not really destined to end up in a region which accounts for just 16% of our total exports, particularly when a quick look around Asia makes it clear that the benefits of technology are not evident through most of the region.
It should be obvious that most of our tech exports to the region are the machines and parts needed to manufacture final products which are destined for economies outside of the region, including the US. This brings us to another statistic. Of the $44.6 bln in electonic machinery and equipment imported by the US in Jan-Jul of 1997, 49.9% or $22.3 bln of these imports are from the aforementioned Asian 8. Even if common sense doesn't tell you that Asia is re-exporting its tech imports, the data definitely should. SE Asia is not the primary end user of technology products, it is just an intermediary, where relatively cheap, skilled labor is employed to use US and other nation's capital and intermediate goods to assemble final products for export. In Mexico, they call these factories Maquiladoras.
Mexico in 1995
We mention Mexico because it offers a case study in US trade with an economy similar in some relevant respects to Asian economies, and which recently suffered a financial crisis triggered by a sharp devaluation of the currency. After the Mexican peso plunged in December 1994, the Mexican economy collapsed, but Mexican exports soared. This result was to be expected -- the peso devaluation reduces the wealth of Mexicans who hold pesos and their spending plunges as a result. At the same time, the weaker peso makes Mexican goods cheaper overseas and thus exports soar. Like Asia, the Mexican manufacturing industry combines cheap labor and intermediate goods imports to produce competitive manufactured exports.
Let's look at what happened to Mexico in 1995. Consumer imports plunged 44% in 1995, which was to be expected as the domestic economy collapsed. Even capital imports suffered, falling 34%, though the comparison with Asia in this case is not completely appropriate given that Mexico's exports are less capital intensive (electrical makes up just 25% of total exports to the US instead of the 50% in Asia). Asian capital imports will not decline as much if demand for exports from capital-intensive industries strengthens, as it should. Most interesting in the Mexican case, however, was that imports of intermediate goods rose 3% in 1995, and intermediate goods made up 81% of total imports. The reason for this modest increase was that these intermediate goods were needed to feed an export sector which boomed after the peso devaluation. Mexican exports soared 31% in 1995.
The Mexican Lesson
The lesson from Mexico? SE Asian economies will suffer, but the one sector which will buck this trend is the export sector, and the sector upon which US tech companies are most reliant is -- you got it -- the export sector. Demand for PCs, monitors, cordless phones, semiconductors, and all manner of final goods manufactured in Asia will strengthen due to the devalued Asian currencies. To keep up with that demand, Asian exporters will continue to demand all of the inputs necessary for the manufacture of these goods.
Where Now?
Companies which benefit from sales to Asian consumers will most certainly suffer from the financial crisis in the region. But tech companies do not fall into this category as SE Asian nations are not significant consumers of tech products -- they are exporters of tech products. As a result, the impact of the Asian crisis on US tech firms should be small even in the case of companies that do significant business in the region (Applied Materials, Intel, KLA-Tencor, Texas Instruments, Ascend, to name a few). And it should be recognized that many tech firms have minimal exposure to the region (Dell, Cisco, Novellus come to mind).
Investors trying to discern which companies will be hurt/help/unaffected by the Asian crisis need to ask the following questions: what percentage of sales does the company derive from Asia? Are sales to Asia dominated by sales to end-users in the region (bad) or are they primarily for manufacture and re-export out of the region (good)? And finally, are sales to Asia primarily capital goods (ie semiconductor equipment) or intermediate goods (ie chips, circuits, disk drives)? The latter fare better. There has been serious carnage in tech stocks over the past week and there may well be more to come in the days ahead. But before the dust settles, the Asian exaggeration should make for some good investments in companies whose Asian vulnerabilities are being substantially overestimated by the market. |
