Foxconn survives on thin slices of Apple
By Sarah Mishkin in Taipei and Maija Palmer in London
Being a supplier to Apple is both a blessing and a curse. Assembling the world’s most high-profile gadgets has been the making of Hon Hai, the Taiwanese contract manufacturer also known as Foxconn. Apple is its largest customer, and the iPhone could make up a third of Foxconn’s profits for the second half of the year by some estimates.
The company is the sole assembler for the iPhone 5 this year, with 80-85 per cent of shipments next year as well, according to analysts at Barclays. At an estimated $8 a phone, that workload brings in revenue, but has also put the company under strain. To handle Apple’s demands, Citi analysts estimate, Hon Hai must increase headcount at its Zhengzhou iPhone factory from 150,000 workers in June to 250,000 in October.Labour shortages have been a widespread complaint among Chinese factories recently, and factory owners, including Hon Hai, have raised wages to entice workers back to the shop floor. This is a delicate balancing act for Hon Hai, which survives on gleaning razor-thin profit margins from the vast scale of its operations.
Even as its revenues have soared since the first iPhone was launched in 2007, Hon Hai’s operating profit margin has more than halved from 5.4 then, to 2.4 per cent in 2011.
Making the iPhone has also put Hon Hai in the spotlight in a way it might not otherwise have experienced, with widespread reporting of a series of suicides among its factory workers in 2009 and 2010, and audits by the US-based Fair Labour Association. Although earlier this year Hon Hai showed progress in resolving a number of labour problems, recent reports suggest that as pressure has mounted ahead of the iPhone 5 launch, complaints about excessive overtime and exploitation of student interns as line workers are increasing again.
Rioting at one of Hon Hai’s factories on Monday indicates this could be coming to a head. They also raise the possibility that Hon Hai, and Apple, would not be able to meet the vast demand for the iPhone 5.
Yet for many of the other companies that supply components for the iPhone, being in Apple’s supply chain is still highly desirable.
“Being in the iPhone is so important for chip companies. Apple suppliers make much higher margins than the rest of the industry, and because Apple only has one leading model of phone, the suppliers are in all of the 200m or so devices that Apple will sell. In contrast Samsung will have many more models and suppliers will be in some but not others of these,” said Dan Ridsdale, analyst at London-based Edison Investment Research.
The components used to make the iPhone 5 are estimated to cost about $199 for the low-end, 16 gigabit model, according to IHS iSuppli, the research group. The bill of materials is higher than in previous models – although, with phones starting at a retail price of $650 each, that still leaves considerable profits for Apple.
One of the most expensive components will be the display screen, estimated to cost about $44 a phone. It is pricier than the iPhone 4S screen partly due to the larger size of the screen and because, for the first time, the screen itself can sense touch – instead of a touch-sensitive layer placed on top of the screen.
Earlier this summer there were fears that the panels would be in short supply, in part because one of the suppliers, Japan’s Sharp, was struggling with financial difficulties.
Now analysts say they are more confident the manufacturers, which also include Japan Display and Korea’s LG Display, have increased their output sufficiently.
Other iPhone beneficiaries include Qualcomm and Broadcom, which are key semiconductor suppliers to Apple. Analysts from Barclays believe that the iPhone 5 will have a communications chip from Qualcomm to allow the new 4G mobile phone connections and a WiFi chip from Broadcom. Both companies have seen their shares boosted over the past two months in the run-up to the launch.
Investor expectation is also high for both Arm Holdings and Imagination Technologies, the UK chip designers whose blueprints are in the core A6 processor chip used in the iPhone 5. The relationship with Apple is partly why both companies’ shares trade at far higher multiples than the rest of their UK peers, about 32 times next year’s earnings estimates for Arm, for example, compared with mid-to-high teens for much of the rest of the sector.
The fear of being designed out of a product haunts investors, however, given the dependency these companies have on a single client. Liberum Capital, the broker, estimates that 30 per cent of Imagination’s £128m annual revenues are attributable to Apple products.
Wolfson Microelectronics and CSR, two UK chipmakers, saw large falls in their valuations after Apple several years ago decided it would no longer use their chips in later versions of the iPhone.
Other losers include Taiwan’s TPK, which supplied the older screen technology to Apple. Although it was widely anticipated that Apple was moving to a touchscreen technology, TPK’s shares have still fallen 6 per cent since the iPhone 5 was unveiled on September 12.
Apple is also thought to have phased out memory chips made by Samsung, which is locked in a number of bitter patents disputes with the US technology group. However, analysts say this might not be bad news for Samsung – the highly commoditised memory chips are a relatively low margin product for the company, and losing it could actually increase the South Korean group’s profitability. Samsung still makes the main A6 processor that powers the iPhone 5. |
