THREAD -- GOOD ARTICLE----December 12, 1997
Production in the Region Will Become
Cheaper, but Sales Likely to Take Hit
For giant disk-drive maker Seagate Technology Inc., there has been no shortage of ripple effects from the economic crises coursing through Asia. The hard part has been figuring out whether the news is bad or good.
This article was prepared by Wall Street Journal staff reporters Lee Gomes, Dean Takahashi in San Francisco and Wayne Arnold in Kuala Lumpur, Malaysia.
Consider: In October, the world's biggest drive maker took a $63 million charge because of a badly timed hedging bet on the plunging currencies of Thailand and Malaysia, where Seagate has many of its plants. While the charge was a shock for shareholders, there was also an upside: The currency declines that triggered it also meant lower manufacturing costs for Seagate, the biggest private employer in those two countries.
<Picture: [Go]>Join the Discussion: Technology stocks' recent rally.
That bit of good news, though, was quickly offset by bad news in South Korea, where a weakening won gave Seagate's competitors like Samsung Group the chance to cut their prices. Panic time? Not so fast. Because of the same South Korean crisis, the likes of Samsung are facing a credit crunch that appears likely to curb their ability to expand operations. That's potentially a big plus for Seagate, because the company is struggling with an industrywide glut of disk drives. But a scarcity of credit is also bad news, of course, since consumers and corporations in South Korea and the rest of Asia will be buying fewer personal computers, in which most of Seagate's drives are used.
Confused? Join the crowd.
U.S. investors are clearly alarmed about the fate of America's highflying high-technology multinationals, and are threatening to stampede out of the sector. The tech-laden Nasdaq Stock Market has sunk nearly 5% this week. Such behavior isn't completely irrational, because the net effect of the Asian turmoil is bound to be negative, at least in the short term. Japan and the Asia-Pacific region, excluding China, represent about a quarter of the global economy, and their collective growth rate may go from robust to nil next year. More than a third of America's $150 billion of high-tech exports go to the region, and the sales of the units of U.S. companies located there dwarf those exports.
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Asian Dependency
Top markets for American high-tech exports
ÿÿÿ ÿÿÿ1996
(billions) % Change
Since 1990 European Union $35.99 ÿÿÿÿ+43.1% Canada ÿÿ24.42 ÿÿÿÿ+80.0 Japan ÿÿ17.98 ÿÿ+107.1 Mexico ÿÿ12.72 ÿÿ+144.5 Singapore ÿÿÿÿ8.02 ÿÿ+160.2 South Korea ÿÿÿÿ7.34 ÿÿ+161.0 Taiwan ÿÿÿÿ5.79 ÿÿ+119.7 Malaysia ÿÿÿÿ4.96 ÿÿ+144.3 Hong Kong ÿÿÿÿ4.92 ÿÿ+195.7 Brazil ÿÿÿÿ4.06 ÿÿ+237.3 Philippines ÿÿÿÿ3.00 ÿÿ+277.9 Australia ÿÿÿÿ2.69 ÿÿÿÿ+57.6 Thailand ÿÿÿÿ2.03 ÿÿ+144.2 China ÿÿÿÿ1.93 ÿÿ+253.1 Israel ÿÿÿÿ1.69 ÿÿ+135.1
Source: American Electronics Association
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But it's proving to be surprisingly difficult to figure out the precise bottom-line impact of the crisis on individual U.S. companies or even industries. Some will be big losers, but others will be hurt only moderately, while others could get off scot-free. That, in turn, is one of the unexpected lessons of the current situation: That answers don't come easily in a globalized economy where countries are simultaneously suppliers, customers, partners and competitors to American companies. While tech companies are the U.S.'s biggest exporters, the rest of America's multinational manufacturers are subject to similar confusion.
International Business Machines Corp. says it has so many plants around Asia -- 14 in five countries -- that it has no central record of all purchasing and manufacturing. And Motorola Inc. says that even to provide a comprehensive accounting of production at its facilities throughout Asia would take several days of calling company executives.
One result is that the next few months may see more weeks like this past one, when companies describing Asia's impact seemed to be on different planets. On Wednesday, for example, Oracle Corp. blamed Asian woes for part of a sales shortfall that drove its shares down 29% in the busiest trading of a major stock in Wall Street's history. But on the same day, executives of Packard-Bell NEC Inc. were predicting that the crisis would actually be good for their business by cutting the costs of components.
To some extent, American investors may not care much about precise answers. They have driven many tech stocks skyhigh in anticipation of enormous growth rates, so even a moderate slowdown could make some currently inflated price-to-earnings ratios unsupportable. Huge uncertainties also unnerve high-tech investors. What if China's currency begins to crumble? What if Japan can't stop the shrinkage of its economy? What if a desperate drive for dollars by the Asian nations causes a world-wide export war?
Right now, the conventional wisdom is that the region is more likely to gradually recover than spin out of control, if the affected countries implement reforms demanded by the International Monetary Fund to root out the core causes of their problems: easy credit, mismanaged banks and misallocation of funds to massive projects run by the cronies of bankers or politicians.
No one knows if these nations have the willpower to implement such reforms. But in the meantime, whether Asia is a problem or an opportunity for American companies depends on what precisely they, and their competitors, do in the region. The crucial factors are the location of manufacturing facilities and customers.
The best situation is to make products in the countries with the most devalued currencies, but sell most of the goods to other, healthier regions. Hewlett-Packard Co., for example, makes nearly half its ink-jet printers in Southeast Asia, where currencies have dropped 20% to 40%. Seagate, based in Scotts Valley, Calif., makes nearly all its computer drives in Southeast Asia. So both companies stand to benefit from lower payrolls, energy bills, maintenance costs and the like, since these overhead expenses are paid in local currencies that have become significantly cheaper relative to the dollars generated by sales.
But the residents of these countries buy only a tiny fraction of the products they make. Even the Japanese and the South Koreans, the No. 3 and No. 6 importers, respectively, of American high-tech goods, are relatively minor markets for H-P and Seagate compared with the U.S. and Europe. So such U.S. companies are somewhat buffered from the recessions and lower purchasing power that are the inevitable consequence of the reform measures being adopted throughout the region.
Seagate, which has 82% of its work force in the region, expects lower operating costs to help offset its recent currency charge of $63 million. More than three-fourths of Seagate's drives go into personal computers or servers sold in markets other than Japan and Asia. Dick Warmington, H-P's managing director of Asian operations, says that the company's exports from its 18 factories strewn throughout seven Asian countries exceed its nearly $7 billion of sales in the region. While H-P buys most of its components in dollars, its operating costs, mainly labor, are dropping sharply.
"It's got to be helping us," Mr. Warmington says.
The Worst Scenario
The worst situation is to be heavily dependent on Asian markets, but make products in the U.S. or, even worse, high-cost Europe. For such companies, the Asian turmoil is a resounding negative. Chief among them are suppliers of the equipment used to make semiconductors, a $28 billion industry dominated by U.S. suppliers like Applied Materials Inc. and LAM Research Corp. The market leader, Applied Materials, gets about 10% of its revenue from South Korean chip makers and up to 25% from Japanese manufacturers. The downturns in Asia have hammered the shares of the equipment makers' stock. Shares in Applied Materials, for example, are off nearly 50% from their summertime highs.
Analysts say this is one case where the market isn't overreacting. "It's serious," says Richard Aurelio, executive vice president of the semiconductor-equipment business for Varian Associates Inc. in Palo Alto, Calif. "Our business will be off in Korea. My gut reaction tells me they're going to spend about 50% less in 1998."
The biggest factor in determining the amount of pain felt by American tech companies is the mix of their customers. Oracle, for example, owns about 80% of the database market in Japan, so it was hurt by the recession there while its competitors were relatively unscathed. In a sense, Oracle is being punished for its success. Meanwhile, IBM, the No. 2 player in database software, reports brisk sales of its latest product in South Korea, Thailand, Singapore and Hong Kong.
The main driver of the U.S. technology boom has been the huge PC industry. International Data Corp., a market-research firm, expects the Asian crisis to shave 1.3 percentage points off 1997 PC unit-shipment growth, to an estimated 14.2%, and about 1.4 percentage points in 1998, to about 13.5%. Rival Dataquest is making similar forecasts. Why isn't it more, given that a Japanese market that once averaged 40% annual growth in units is now seeing a decrease of 5% to 10% from last year?
Partly because the Japanese market has been a difficult one to penetrate, and only amounts to 11% of global PC shipments. Apple Computer Inc. succeeded there the most, and it, like Oracle, has been hammered by the country's downturn. At the same time, demand for PCs priced for less than $1,000 is surging in the U.S. market, which accounts for 36% of world unit sales, while sales are recovering strongly in Western Europe, which buys 23% of all PCs.
"The good news is that Europe has come on like gangbusters," says Earl Mason, chief financial officer of Compaq Computer Corp., the world's biggest PC maker. "That is one advantage of a global company, in that when one part of a market falls off, another market can bring you up."
Growing Market
Moreover, China's demand for PCs continues to swell, with government officials estimating that unit shipments will grow to 10 million a year by 2000 from a current annual rate of three million. Such growth would make China's PC market nearly as large as Japan's. Thursday in Beijing, Microsoft Corp. Chairman Bill Gates conceded that "this year, [the Japanese market] won't grow very much at all," but "for us, China is doing very well and we don't see any signs of that changing." H-P sees the same phenomenon. Jim McDonnell, world-wide marketing manager for H-P's PC group, says his company sells as many PCs in China as it does in "four or five" countries in Southeast Asia.
PC makers also assert that the devaluations will boost sales in the U.S. and Europe by shaving $100 or more per computer off the cost of disk drives, monitors, keyboards, memory chips and other components bought from Asian plants. In other words, here come lower-priced PCs. "As components get cheaper, that will help us drive new price points, like for the sub-$1,000 PC," says Mr. McDonnell.
In Asia itself, some customers are less durable than others. Motorola's consumer customers in the region, who buy its pagers and cell phones, won't be able to continue their past rate of consumption. "The growth is going to slow down," predicts H-P's Mr. Warmington. "There's less money to spend for these kinds of products."
American equipment makers are also likely to lose some important future infrastructure contracts. But few analysts expect many current contracts to be abandoned, or that future spending on telecommunications will grind to a halt. So another big part of Motorola's business -- telephone infrastructure equipment -- will be buffered. "Are these countries not going to connect to the Internet?" asks Lee Doyle, an IDC analyst. "That would be wacky." Indeed, Thursday a consortium of telecommunications giants in Japan, China, South Korea and other Asian countries announced $1.1 billion of contracts to build an undersea cable linking China and North America.
Small Cuts
And the Japanese chip makers, who made billions of dollars during a long memory-chip boom that ended two years ago, assert they are much better positioned to keep buying equipment from American companies than their big Korean rivals. Fujitsu Ltd. and Hitachi Ltd. both said recently that they will cut capital spending by only 6% and 7%, respectively, in their current fiscal years.
Jim Morgan, Applied Materials' chief executive officer, says none of the chip giants can delay equipment purchases for long because the entire industry is making a crucial transition to a more-miniaturized manufacturing process. "If they don't invest, they don't compete," he says.
In truth, many American technology companies have bigger problems than Asia. Analysts are starting to suspect that companies are using the turmoil there as a convenient cover for management blunders here. While Oracle asserted that most of its sales shortfall occurred in Asia, analysts believe its real challenge is a loss of market share in the U.S. to competitors in databases and database applications. Technology leader Intel Corp. is sacrificing profit margins to fend off cloners of its chips. Seagate is plagued by a price war and glut caused by its American rivals.
Asia "is not even in the top three things we're worried about right now," says Donald White, Seagate's chief financial officer.
Improving Climate
Nonetheless, it's easy to see how the fearful investor psychology created by the Asian crisis could do long-lasting damage to the shares of the American high-tech companies. Investors learned to expect not only higher growth rates, but unexpected bonanzas.
But over the long haul, the business climate for American companies in Asia could actually be better than before the crisis. The IMF is trying to force the Asian nations to stop subsidizing the kind of overcapacity that has hurt U.S. companies in markets ranging from drives to memory chips to cars, and Japan's battered banks are being forced to take similar steps on their own. Last month, for instance, Dongbu Group, a South Korean conglomerate, announced plans for a $2 billion chip plant. Industry sources say the plant will now be delayed for many months, and may never be built.
The IMF is also bent on prying open markets that have been partly closed to American concerns. South Korea is the most notable example. "It is a market that is increasingly opening up to us," says Lydia Whitefield, a spokeswoman for Lucent Technologies Inc., the giant maker of telecommunications equipment.
--Jim Carlton in San Francisco and David P. Hamilton in Tokyo contributed to this article.
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