Jim:found this in a Barron's article.DGN mentioned halfway thru the
article! let me know what you think.
matt
December 29, 1997
Finding Bargain Stocks Behind Famous
Nameplates;
Software Titans Engage in a
Knock-Down, Drag-Out Fight
By ERIC J. SAVITZ
Things aren't always what they seem. Say, for instance, you were to
buy some computing gear from Cisco Systems, Hewlett-Packard or
Sun Microsystems. You'd likely assume, if you even stopped to think
about it, that the hardware you'd bought had been manufactured by the
company that put its nameplate on the front. As it turns out, however,
there's a pretty good chance you would be wrong. And the same goes
for products from companies like Apple Computer, IBM, Lucent
Technologies, 3Com, Bay Networks, Silicon Graphics, AT&T and
Ericsson. To one degree or another, they've been farming out
manufacturing of key products to outsiders.
In short, business is booming for the oft-ignored, unglamorous
technology sector called contract electronics manufacturing. Frost &
Sullivan, a Mountain View, California-based research firm, earlier this
month forecast 26.1% compound growth for the contract manufacturers
stretching out to 2004. By the end of that span, they project, the
industry will have revenues of $110 billion. Want more evidence?
Consider the recent performance of Solectron, of Milpitas, California,
one of the largest players in this fragmented field. In its fiscal first
quarter, ended November 28, Solectron reported a 41% increase in
sales, to $1.1 billion, as pershare earnings improved to 38 cents, from
29 cents. Though estimates were a tad higher, the stock had sold off
ahead of time, and it actually rebounded nicely on the news. Investors,
in particular, were encouraged by Solectron's observation that its results
had not been affected by the Asian currency crisis.
Even with the post-earnings bounce, though, Solectron's stock, now
trading in the high 30s, sits more than $10 below its October peak.
Alexander Blanton, an analyst at Ingalls & Snyder, a New York
investment boutique, thinks the stock market has dished out
unreasonable punishment to the shares of contract electronics
manufacturers. That goes not just for Solectron, but also SCI Systems,
the leading contract manufacturer for the PC industry, and a host of
smaller companies, including Flextronics International and DII Group.
Wall Street seems convinced that these companies will suffer severe
consequences from the ongoing Asian economic crisis. As Blanton
observes, however, while some of them run facilities in the Pacific
Rim, they operate them mostly for Western companies, selling and
buying goods in dollars and European currencies. Blanton says they
should feel little bottom-line impact-if anything, they will benefit from
reduced labor costs.
Meanwhile, the news on the industry continues to remain uniformly
positive. Not long after the solid earnings report from Solectron, rival
Jabil Circuit likewise came through with a market-pleasing quarter. And
there's additional evidence of the growing move toward contract
manufacturing: NCR this month agreed to outsource its
computer-manufacturing operations to Solectron for at least five years;
Solectron will acquire three NCR facilities, with 1,200 employees.
Waxing Enthusiastic
"The business outlook for these companies has been getting better and
better, particularly in Europe," Blanton enthuses. "These companies are
now doing all kinds of activities beyond circuit-board assembly, which
is where the industry started. Some of them are full-service facilities,
providing design and engineering services, packaging consulting, test
development, prototyping, procurement, board assembly, software
duplication, order fulfillment. You can start a tech company now and
not do any manufacturing."
The contract-manufacturing stocks, he says, boast strong, steady,
predictable growth. Blanton figures they deserve to trade for a
price-to-earnings multiple at least equal to their annual growth rate -- but
none of them do. Solectron, he notes, trades for about 24 times
expected calendar 1997 earnings of $1.47 a share. In 1998, he says,
profits should jump to $1.97 a share, an increase of nearly 35%,
making for a below-market P/E of 18. Blanton likes both Solectron and
Flextronics, but his favorite stock in the sector is the aforementioned
DII Group, a smaller company that trades for an even lower multiple.
DII has some unused manufacturing capacity, giving it considerable
operating leverage.
SCI Systems, Jabil Circuits and Sanmina, he says, aren't quite as
cheap. Nonetheless, all of the stocks in the group trade at a discount to
the industry's growth rate. The bottom line: Blanton sees strong
prospects for all of these stocks: "Growth is going to be huge."
Charles Cory, who heads Morgan Stanley's high-tech M&A group,
expects to find plenty of work in 1998. In particular, he foresees
consolidation in three key parts of the tech landscape: software,
communications equipment and computer hardware. Software, he
observed over a recent breakfast in Palo Alto, "is the space that's all
screwed up." Not PC software, of course; that part of the market has
more or less been conceded to Microsoft. But the market for "enterprise
software," meaning big programs bought by companies, remains
seriously fragmented. Cory says five companies -- Oracle, Baan,
PeopleSoft, SAP and J.D. Edwards -- have become embroiled in a
"knock-down, drag-out fight" over the sector. Meanwhile, he says,
there are "a bazillion one-trick ponies with 200,000 lines of powerful
code; they are product lines masquerading as companies." A lot of
those, he expects, will become acquisition bait. A case in point: IBM
last week agreed to pay $200 million to buy Software Artistry, which
makes help-desk programs.
Cory doesn't expect to see much consolidation in the PC sector, but he
expects considerable activity among makers of mid-range and high-end
servers. This includes companies like Data General, Sequent Computer
Systems, Stratus Computer and Silicon Graphics. Among possible
acquirers, Cory lists IBM, "which has a $100 billion market value, and
no growth"; Compaq, which has already taken steps to move into
high-powered systems with its acquisition of Tandem Computers, and
Hewlett-Packard, which Cory believes needs to better focus its business
and boost its growth rate. Another possibility, Cory says, would be the
consolidation of high-end data storage companies, like EMC, into the
computer makers. In the networking industry, Cory says, the old-line
communications equipment companies, like Lucent Technologies,
Nortel, Siemens, Alcatel Alsthom, L.M. Ericsson, Philips Electronics
and Nokia, have plotted a collision course with the data communications
firms, like Cisco Systems, 3Com and Bay Networks.
"The convergence of data and voice is a freight train," he says. "People
had better get their brains around that." Aside from Cisco, almost any of
the data communications companies could end up getting swallowed by
their deeper-pocketed rivals. Cory advises keeping an eye on Lucent
starting in late 1998. At that time, the company, which was spun out of
AT&T in 1996, will be freed from a restriction that prohibited it from
making acquisitions using the favorable pooling-of-interests accounting
treatment.
Michael Slade, the outspoken chairman and CEO of Starwave, which
runs a number of popular Web sites, including ESPN Sportszone and
ABCNews.com, recently made a provocative observation that bodes ill
for all those Internet sites counting on advertising to pay the bills. The
conventional wisdom, of course, is that advertisers will pay a premium
to get the highly targeted audiences that some sites can deliver. But that
theory has a deep flaw. "The more involved people get with the
content," Slade observed in a panel discussion at the Personal
Technology Outlook conference earlier this month in Burlingame,
California, "the less likely they are to click on advertising. We need to
find other ways to make money from people."
Speaking of which, Dan Okrent, the new media editor at Time Inc.,
thinks truly valuable sites will eventually have to charge for their
content. "That which we do not sell, we eventually devalue," Okrent
said in a speech at the same event. As it happens, one publication that
seems ready to test that theory is none other than Slate, the online
magazine published by Microsoft and run by former New Republic
Editor Michael Kinsley. Slate just announced that sometime early next
year it will make its second attempt to charge a subscription fee. In an
infamous experiment, Slate initially charged readers, then switched to
free circulation.
Okrent, meanwhile, has dusted off the old view that print is dead: "It's
as relevant to our future as the carrier pigeon. Last year, Time Inc. spent
$1.1 billion on paper and postage. End of argument."
The final panel at the above-mentioned conference, run by new
York-based Technologic Partners, asked a small group of investment
pros to choose from among the dozens of presenters at the forum those
with the best chance for long-term survival. Their top choice: HotMail,
a Sunnyvale, California, company that provides free E-mail service via
the Web. Sabeer Bhatia, president and CEO, says HotMail has over
nine million active Email accounts, more than any Internet service aside
from America Online.
With about three million unique visitors a week, it's become one of the
most heavily trafficked sites on the "Net. The danger for the company is
that free E-mail is cropping up all over the Web -- Excite, Yahoo!, and
Lycos all offer free E-mail, for instance. To keep people using its own
service, HotMail will have to add some other features.
Feel left out from the lynch mob at Microsoft? Visit the "Punch Bill
Gates" Web page (www.well.com/user/vanya/bill.html). Feel better?
Then celebrate the season of giving. Send along tips, rumors,
harangues, whatever to savitzbarrons mag.com.
Copyright c 1997 Dow Jones & Company, Inc. All Rights Reserved. |
