CEMs: Wall St.'s new darlings -- Growing importance of
outsourcing piques investor interest
Jennifer L. Baljko
Silicon Valley- When Solectron Corp. and other well-established contract
electronics manufacturers were the new kids on the technology block several
years ago, Wall Street analysts barely batted an eye. But as the stigma of
outsourcing fades away and CEMs play a strategic role in the success of their
OEM customers, the sector has become somewhat of the darling of the
financial community.
Today, nearly every major investment banking house-and a number of smaller
boutiques- have initiated coverage of CEMs, memory-module manufacturers,
and other subcontractors.
"Once the [CEM] stocks started to consistently rise, the companies were
acquiring OEM assets, and they were generating earnings growth of 30%,
35%, 40%. That's going to wake the sleeping dragons on Wall Street," said
Herve Francois, an analyst at Credit Suisse First Boston, New York, which
just launched coverage of 10 CEMs this summer.
As the names of CEMs started to become recognizable in financial circles and
investors and money managers came up to speed on trends and potential
gains, the firm's clients began clamoring for research reports, he said.
"Clients were saying, 'Here is an attractive group of companies with a dynamic
growth rate; we would like you get more involved here,' " Francois said. "And
when you look at other sectors, like the connector market or distribution,
they're dead right now. The only thing that has any kind of pulse right now is
contract manufacturing."
For many publicly traded CEMs, the higher number of analysts tracking their
progress has put them under increased scrutiny.
For example, just four years ago, only three or four investment companies
followed Solectron with any amount of regularity. Today, 18 firms have
assigned equity analysts to cover Solectron, according to Nelson's Directory
of Investment Research, published by Nelson Information, Port Chester, N.Y.
"For the first few years of being a public company, we had no takers," said
Susan Wang, Solectron's chief financial officer. "Recently, we've been getting
a lot of attention as a result of the relentless efforts we've made on behalf of
building recognition for the entire EMS industry."
The spurt in coverage, in many cases, comes down to a few basic factors.
First, some of the investment firms became familiar with CEMs because they
represented them in stock deals or acquisitions. Others added CEMs to their
coverage because they were watching related industries such as OEMs,
distributors, and component suppliers.
Others had the foresight to see the trend that was developing as OEMs
reduced their own manufacturing operations to focus on core competencies
and boost sales and earnings.
Another factor is Institutional Investor Magazine's decision to list the industry
as one of the 80 categories upon which analysts can be ranked. This year, for
the first time, the widely read financial magazine will include the EMS sector in
its annual All-America Research Team list, which ranks the top-performing
analysts in each area, according to Laurie Meisler, the magazine's assistant
managing editor.
The most fundamental reason for the increased coverage is the booming
business itself. Unlike other portions of the electronics industry, the CEM
market is expected to grow 25% to 30% a year.
Like other tech stocks, the sector has been hit hard this year and is
underperforming the broader stock market to date. Still, the return on invested
capital is running about 18%, outpacing the 7% rate posted by the S&P 500,
said J. Keith Dunne, a BancBoston Robertson Stephens analyst who has been
tracking the industry for two years.
"There's a double shotgun effect here," he said. "They've improved return on
invested capital and they're investing at a faster rate."
That return rate, combined with the outsourcing trend, is what inspired Advest
Inc. to add the group to its portfolio, according to David T. Parrish, an analyst
at the firm's Boston office.
"Today, large OEMs are outsourcing their manufacturing requirements," said
Parrish, who initiated coverage about 18 months ago as an extension of his
research on telecommunications companies. "There's still a lot of opportunity
in outsourcing. If you look at the major drivers in the market, networking and
telecommunications companies are just getting started with this. They're facing
shorter life cycles, advances in technology and pressure to reduce costs. The
contract manufacturer provides solutions for them."
Given the appeal CEMs have been exuding in a down electronics market, it's
no surprise to industry veterans that more voices are being heard on quarterly
conference calls.
"I wouldn't be surprised if more join the ranks," said William E. Cage Jr., an
analyst at J.C. Bradford and Co., Nashville, who has tracked the industry
since 1992, making him a pioneer. "We saw this coming as a major trend, and
now it is."
Even CEM executives don't mind the attention, although it does sometimes put
additional pressure on companies to meet expectations, and creates a
challenge in dealing with so many people.
"Each analyst brings their own perspective, and that increases the burden of
communicating our message consistently and effectively," Solectron's Wang
said. "For a long time, we were seen as a fly-by-night business, and that we
existed at the whim of the OEM. Now, we are being recognized as a true
manufacturing solution that OEMs and Wall Street can value."
ya gotta love it.patroller
|
