Silicon Valley Not Paved with Gold

Is the bloom off the rose in the Silicon Valley?

For years, manufacturers have insisted on putting factories in the greater San Jose area. The CIRCUITS ASSEMBLY Directory of EMS Companies lists hundreds of entries with Silicon Valley zip codes. Damn the costs — siting near customers — actual or desired — takes precedence!

In the first quarter, the most up-to-date data available, industrial space vacancy rates were 2.7%, near an 18-year low. That’s despite more than 200,000 sq. ft. of new industrial space coming online in the period, on top of about 3 million sq. ft. of new industrial space that came online last year.

Ironically, industrial space rents, while climbing, are a relative bargain. The average rent was $1.27 per sq. ft. in the March period, more than twice that in 2010 ($0.60 per sq. ft.), but well below the national average. That comes to more than $381,000 in rent a year for a modest 25,000 sq. ft. factory. But tack on energy, and labor costs — unemployment rates are not only lower than the national average, but workers earn a small fortune — and it all adds up to a very expensive enterprise.

Today the pendulum is shifting, if only bit by bit. We are seeing furloughs, layoffs and even some big names starting to blink. Jabil, Creation Technologies,
and this week, Benchmark are among those closing factories in Silicon Valley.

Will more follow? In an industry where margin and cash flow often make all the difference, it won’t be a surprise if more players head for lower-cost pastures.

What’s the Deal with Delly?

Gayla Delly left Benchmark with no notice last week. Why?

Changes at the top of Tier 1 and 2 EMS firms don’t happen often. Before Friday, in fact, Benchmark had had just two chief executives in its 30-year history.

Cary Wu founded the company as part of a buyout from medical device manufacturer Intermedics in 1986. He remained in charge until December 2011, when he promoted Delly, the company’s longtime head of finance, to the top spot.

Highly dependent for years on the high-end computing sector, especially IBM, Benchmark had been trying to balance its portfolio via acquisitions. With its acquisitions of Suntron and the EMS operations of CTS, both in 2013, the company attempted to broaden its reach into the high-reliability industrial, medical and aerospace/defense markets. It then snapped up industrial communications OEM Secure Technology in 2015.

Many bigger EMS acquisitions are slow to be accretive. The large amount of fixed assets and (typically) lower capacities at the acquired company mean layoffs and restructuring costs will follow. Still, investors are impatient and the deals were met with criticism in some quarters.

Much like Sparton and its now-departed CEO Cary Wood, Benchmark faced strong opposition from a loud activist investor who accused the EMS company of poor fiscal management. (Interestingly, unlike many of its similar-sized competitors, Benchmark has typically been patient with its M&A strategy, choosing to keep its debt levels low.)

The intensity of that criticism, which was public in the spring, had quieted down during the summer after the investor won two board seats. On its quarterly conference call in late July, Delly went to far as to deny any strategic changes in the direction of the company following the seating of the new directors. This makes the timing of Delly’s departure all the more curious.

Last Friday, the announcement came that Delly was being replaced as president and chief executive with veteran electronics executive Paul Tufano, effective immediately. Tufano is a Benchmark board member who has spent more than three decades in the technology and telecommunications industries, most recently as chief financial officer of Alcatel-Lucent. He also has a background in EMS, having been executive vice president and CFO of Solectron. It’s possible the move implies the company will refocus its sights on computing and telecom. We shall see.

Neither Delly nor the company has yet commented on the change.


M&A is Here to Stay

There’s been a flurry of EMS acquisition activity of late, with Natel’s acquisition of EPIC Technologies and Benchmark’s pickup of Suntron and CTS among the larger deals. Lincoln International, an M&A advisor, counts nine transactions in the fourth quarter alone, out of 24 total for the year. While Lincoln’s numbers shouldn’t be considered absolute – my guess is that worldwide they are off by well over 50% – they do provide a reasonable snapshot of the industry at a given time.

While I dare say Nam Tai will be the largest EMS company to close its doors in 2014, when all is said and done, I predict we will see a record number of shops close or be bought out in asset deals.

Benchmark’s Latest Acquisition

Is Benchmark’s acquisition of CTS a good move?

Yes, it says here, and for multiple reasons. In no particular order:

1. Profits. Benchmark says the acquisition will be accretive starting in fiscal 2014, which suggests they think they can make it profitable in short order (Bench’s fiscal year ends Dec. 31.) Before reporting successive losses in the first and second quarters of 2013, CTS had turned in 10 straight quarters of operating profits.

2. Integration. It’s true CTS’s first-half revenue ($97 million) was down from 2012 ($148 million) and 2011 ($158.4 million). For that matter, it’s down versus 2008 ($197 million, ’09 ($146.6 million), and ’10, too. It compares most closely to 2010 ($122.6 million). But to be fair, CTS has been closing plants, which in part drives the revenue loss. (Of course, had those sites been profitable, perhaps they’d still be open.) This may play in Benchmark’s favor in that the organization as currently sized should be fairly easy to integrate.

3. The better mix will help margins. IBM was 21% of Benchmark’s revenue in 2012, more than twice the percentage in 2010. Benchmark has been looking to balance its (over)dependence on the computing segment. CTS is focused on industrial, automotive, aerospace and defense. This pickup will definitely help.

4. CTS’s footprint is in areas where Benchmark is strong. The deal includes five sites, four in North America (two in California, one in New Hampshire and one in Mexico) and one in Asia (Thailand). (While CTS still lists two EMS sites in Scotland and one in China on its website, these have either are already closed or are now being shut down.) As for the acquired sites, CTS will shut down the sites that they can’t fill, and move production to existing plants. They might lose a few customers along the way, but probably not so much that it will hurt them. Moreover, the deal doesn’t force Benchmark to learn a new region on the fly.

5, Benchmark’s track record with acquisitions is good. That’s not to say every site remains open. Far from it. But Benchmark doesn’t bite off more than it can chew, and that’s improvement in industries as cyclical and cash-intensive as EMS.

Since CTS is losing money, good luck calculating the valuation as a multiple of earnings. In that regard, the $75 million price tag seems a big high. By comparison, Benchmark paid $19 million in June for Suntron, which had sales of about $70 million. Given that CTS is more expensive, I’m guessing it is operating closer to breakeven than Suntron was.


Brazilian Blowup?

Which way is Brazil headed?

It looked up, after Foxconn decided to invest — how much is the subject of much speculation, as one report pegs it at about $500 million, another at as much as $12 billion — in new manufacturing campuses in São Paulo and elsewhere.

But Multek recently bailed, leaving the country without its largest bare board fabricator, and now Benchmark is leaving too, citing customers that were “challenged by some of the regulation challenges there.”

Brazil has eased some of its notoriously rigid (and expense) laws that taxed imports, rules designed at essentially forcing companies to build their supply chains inside the nation. It’s a tremendous potential market, with nearly 200 million residents. A few companies leaving isn’t necessarily a trend. But the flow always starts with a trickle.




Thai Floods’ Hidden Asset

In a perverse way, the flooding in Thailand might have a hidden benefit — it could help boost pricing in a way the market otherwise would never allow.

Seagate today said as much in an SEC 8-k filing. The HDD maker noted the severity of disruption the floods have wrought on the hard drive supply chain, causing it to project total industry shipments of 110 million to 120 million units for the quarter. That’s in line with IHS iSuppli’s forecast of a 28% year-over-year drop. Better rethink gifting a  PC for Christmas.

But there quite possibly a silver lining. When capacity is reduced and demand is constant, prices rise. Deutsche Bank senior analyst Sherri Scribner said as much today, noting “Despite the significant shortfall in total available market this quarter, we believe Seagate and the industry will see a gross margin benefit from HDD supply disruptions. As we have already begun to see in the channel, limited availability of HDDs is driving prices higher and pricing is the primary driver of gross margins.”

She also points out that the effect will be lingering, as HDD pricing is set based on prior quarter prices.

We saw this a few years ago, when a fire at ASE in Taiwan took an estimated 10% of the world’s flip-chip capacity offline and pushed up prices and delivery times for several quarters.

The electronics supply chain has long been in dire need of a little inflation. This could help.

5 Predictions for the Second Half

Here’s my 5 predictions for the second half of 2010.

  1. All of 2009’s 10 largest EMS companies – Foxconn, Flextronics, Jabil, Celestica Sanmina, Cal-Comp, Elcoteq, Venture, Benchmark and Plexus – will be intact at year end, and with the exception of Elcoteq, will finish 2010 in the same order.
  2. One of the mid-tier publicly traded EMS companies will be acquired, however.
  3. Component availability issues will not ease until mid 2011.
  4. Foxconn’s many employee problems will blow over as the media tires of the story.
  5. “Computer-aided innovation” will become the big buzzword in software.

Blue Sun

IBM’s potential merger with Sun is hardly a done deal, and reporters at The Wall Street Journal and elsewhere now think the deal may be off. (For the record, neither OEM has yet commented on the deal.)

Which, for EMS companies, is probably just as well. Deutsche Bank estimates a merged IBM-Sun would be able to cut as much as $1 billion in costs from the bottom line. Some of that, no doubt, would come from deleting redundant product lines and even greater buying leverage with the companies’ respective suppliers.

Sales to Big Blue make up about 10% of the revenues at Celestica, Benchmark and Sanmina-SCI, five to 10% of Jabil’s revenue, and two to five percent of Flextronics’ sales. Several of those companies supply significant volumes to Sun as well.

Faced with the pullbacks of Nokia and Alcatel-Lucent, which took some $6 billion combined out of the EMS industry’s collective pockets, word that a deal is off should touch off industry rejoicing, even if just for a day.

If anyone has reason to be sad about the reported deal’s collapse, it would be Sun, which was already on shaky ground. Instead of Big Blue, Sun might turn out to be just blue.