Comparing apples with oranges.
FLEXF has become a large international player, with major operations on three continents catering to Fortune 500 type of customers mostly handling large annual contracts from $30M to $350M. They probably have a half dozen contracts that exceed Deswell's annual revenues. Deswell doesn't really compete with Flextronics much (yet). In assembly, Kwanasia is probably ranked below 300 other companies (in size), whereas Flextronics will probably be number 5 in the world this year. Flextronics has less single market risk, less single customer risk (now that they have purchased Neutronics, they are much less dependent on Ericsson), less single product risk, and has a more stable customer base (Ericsson, Nokia, Phillips, Lucent, Cisco, 3Com(USRobotics), Advanced Fibre, Ascend, Microsoft and WebTV, Lifescan(J&J), Braun, and recently Seimens and others. These guys read like a Who's Who of telecom and networking versus the Inter-Tels and Nam Tai's of the world. A larger part of Flextronics revenues is from assembly.
I don't think you can compare the two- they really are quite different companies. You especially can't compare as easily as just looking at the numbers, especially FY98 numbers. Both companies' fiscal years end in March, so the FY98 numbers are trailing numbers. Since FLEXF will have increased revenues by 150% in FY98, largely due to acquisitions that issued some new shares, and because they will increase revenues again by 80-100% this year, the FY98 earnings per share don't mean much. The FY99 consensus earnings are currently estimated at $2.40 a share, which I estimate is only a 3.2% AT margin. If Flextronics margins eventually increase, which I believe they will do, the earnings could hit $2.80 (or higher). So right now the forward PE is about 17 for a 50% grower, and the forward PSR is around 0.64 (compared to Deswell's forward PSR of about 1.50). And the margins should continue to increase in upcoming years. The margins have a lot of room to improve as expansion costs are left behind. So Flextronics margins have nowhere to go but up in the coming years on a tremendous revenue stream, whereas Deswell's margins will eventually drop toward levels that are more normal for this industry. But then the market has more than discounted that beyond all reason for Deswell.
I bought Flextronics at an average price of 20 last year at this time, and have made a good investment, and expect the revenue growth to be good with expanding margins. If they get expanding margins, then their earnings will outgrow Deswell, because their revenue growth will higher than Deswell. But then the market has bid up the price of FLEXF for this and the other reasons I mentioned above.
The sweet spot for ECM stocks is expanding revenues, expanding margins, and expanding PEs. FLEXF has expanding revenues and margins going for it, although at the current time the PE isn't as good as recently. I'm not recommending people rush out and buy it now. Deswell has expanding revenues and hopefully an expanding PE going for it, but Deswell's margins must be close to maxed out. I am recommending, and buying Deswell now (Friday at 19 1/2), because I believe the market has overly discounted the potential risks and problems, and because I believe the deterioriation in margins will be very slow and more than canceled out by Deswell's growth.
In my post, I was asked to comment on Deswell's 3-5 year growth prospects. Then my reply was used to evaluate the stocks based on the trailing year's numbers. I wasn't really intending to compare the companies or the stocks! I simply tried to identify that there were other players in the Chinese market who did similar things to Deswell, and that these players were in a better position to take major contracts from major companies. But there still appears to be a significant market for Deswell, in spite of this, but this is important to consider when talking about long term growth. I was trying to throw some caveats in on my forecast of a long term growth rate of 35% for Deswell.
Lets face it guys, Deswell is a very small company, and will not be a major international player. If the marketplace decides that they need to be a major player, Deswell will be at a competitive disadvantage. And most of the history of competition in growth markets show that the number of players decline and the size of the competitors increase as the market grows large. No industry I know of (other than US banks...maybe) have the sheer number of competitors and low market shares that we see in the ECM sector. The largest player has about 5% of the market. Deswell has much less than 0.1% of the market. These issues are the correct issues to discuss when you look at long term growth rates.
Another way to look at it: a world class material management system for assemblers costs between $5M-10M, as evidenced by recent expenditures by Solectron and Jabil. How can Deswell(Kwanasia) afford this kind of system based on only $30M or so of assembly business? And the list goes on and on of expenditures need to stay on the cutting edge of technology.
Paul |
