Here is my read, for what its worth.
The downdraft today I think was mostly started by Quantum's earnings warning. In Quantum's press release, they said the HDD business was very weak, with margins declining significantly even though unit volume remained the same. However they indicated in the conference call that they planned to cut HDD production volume by 10%. Quantum also revealed that earnings from their DLT business were going to be flat this quarter due to a product transition phase. DLT is a back-up storage tape device for servers, Quantum has almost no competition in this product, and DLT revenues are expected to grow 100% over the next year and contribute about 40-50% of Quantum's profits. (If you want to know more, go read the Quantum thread)
The Quantum news really hit the ECM sector because Jabil is the sole source supplier of the DLT device, and it constitutes about 22% of Jabil's revenues. The market pounded Jabil about 5 points on the news, and most of the rest of the ECM stocks went down "in sympathy". Incidentally, I don't own any Jabil, but I think this sell-off is unwarranted. The DLT is transitioning to larger units (7000 series) and Quantum is essentially selling all the new units Jabil can make. As Jabil ramps the new unit volume up, I expect that Jabil's revenues will actually grow. Quantum announced that this product's revenues will grow 100% over the next year, and so I expect this 22% of Jabil's revenues will grow at least 100%, maybe more because unit pricing will decline, so unit volume (how Jabil gets paid) will grow more than 100%. I think the sell-off in jabil is nonsense, and I expect jabil to report record earnings next Tuesday after the market close.
More specifically to your questions about the Asian situation. The 10% drop (limit move) in the Korean currency last night, on top of 10% limit drops each of the preceeding days, has now put that currency down about 70% in the last month. The massive amounts of debt racked up by the Korean cabols is coming home to roost. Hopefully the Korean currency will finally find a support level tonight. This has really put the crimp on semiconductor and semi-equipment stocks. I'm very glad I don't own any of those stocks. The pressure on the Asian companies to dump semis to raise cash is huge and their financial ability to buy semi-equipment is getting seriously restricted. I expect that Asian crisis will hit those sectors of the high tech world significantly, and wouldn't expect a bottom until next summer.
But what does this mean to the ECM sector? If the price of chips, hard drives, computers, wireless phones, etc. drop significantly, what will happen to demand? We will see a sizable increase in demand volumes, especially as long as the economies of the Americas and Europe remain strong. Even in Asia, I think the demand will drop in countires like Taiwan, Korea, Indonesia, Thailand, etc., but as their local currency drops make their countries more competitive for investment with China, this period too shall pass. In the meantime, I expect growth in China to continue, and China is becoming a huge market. Overall, I expect significant unit growth for electronic devices made by ECM companies, and therefore significant ECM sector revenue growth because revenues are tied to unit volume growth for this sector.
I don't believe there is significant independent Asian electronic manufacturing capability that will compete with companies in this sector. The largest Asian ECM capacity is owned by the big players in this sector. Existing Asian OEMs could decide could take their existing plants and try to enter the ECM business, but I think this us unlikely, since it probably would involve new investments in equipment and new organizational systems. The ability of Asian companies to purchase equipment and enter this business is limited due to the current financial crisis there. At one time I felt that Asia would become the center of the ECM business world-wide, and I have invested in companies like Flextronics, Solectron, Nam Tai, and Deswell, that have significant Chinese capacity. But now, the model in the industry seems to be to seek out low labor cost sites in each geographical region. I have posted on this before: I expect China, Malaysia, Mexico, Brazil, somewhere in Eastern Europe (Hungary), perhaps India, to become ECM manufacturing centers. Time to market is critical, and ECM capacity must be reasonably close to the final market, and the organization managing the manufactruing process must be able to bring new products on rapidly (see discussion of DLT above). Remember that the labor costs in a low cost country (like Hungary), is only about 10% of the cost of manufacturing (in the US it is higher). This business is not going to move long distances based on short term factors. The major threat to US based electronic manufacturing used to be Asia, now I think a manufacturer would look hard at Mexico before going to Asia.
Given the big correction in the high tech arena, i still think ECM has the best risk/reward in the high tech world. I expect a good report by Solectron on Monday (particularly due to their huge new plant in Mexico), and on Tuesday, Jabil will report record revenues and earnings. Both companies will have reasonable forward looking statements for analysts, since both have announced and are building big capacity increases recently.
I am mystified by the sell-off today; if my reading of the tea leaves is correct, we will see a U-turn next week. I know markets rarely act like that, but I simply don't see this sell-off continuing. The Asian crisis as a whole, has a positive impact on the sector.
BTW- the most signicant news I read today was the decision by AT&T to invest $1.25B in @Home. Cable modem service is coming, and the world will continue to march on toward the new technologies.
Paul |
