Fabrinet’s Changing of the Guard

Were you as surprised as I was at Fabrinet’s choice of a new CEO?

During the 17 years of its existence, having been formed in 2000 when ex-Seagate exec Tom Mitchell took on the lease of his former employer’s plan in Chokchai, Thailand, there has been no EMS company so successful over the past two decades. That initial $21 million investment is now worth $1.35 billion in market value, not to mention the consistently most profitable business in the industry.

It would have been conventional, then, had Mitchell chosen longtime No. 2 Harpal Gill to assume the mantle. Dr. Gill has been Fabrinet’s chief operating officer since 2009 and president since 2011.

Instead, Mitchell went outside for Grady Seamus from rival Sanmina, where he headed the  Mechanical Systems division.

Some analysts believe the move foreshadows a coming diversification from fiber optics into non-optical manufacturing. Writes Stifel Nicolaus’s Patrick Newton:

[W]e see Seamus as having extensive leadership experience with both optical manufacturing (background at Lucent; Mechanical Systems Division at Sanmina manufactures the cabinets/chassis/frames/racks/ and storage cabinets integrated with electronic components and sub-systems that optical components are supplied into) and non-optical manufacturing (focus Medical experience at Sanmina). We view this competency in both optical and non-optical manufacturing as likely to be an aid in helping the company move beyond its optical focus to a 50/50 optical/non-optical mix long-term. We emphasize that our recent conversations with Fabrinet’s management highlighted that Fabrinet was targeting its next CEO to have a combination of operational excellence, deep technical expertise, and strength with customers as they will have to be customer facing.

Mitchell set the bar so high, any successor would be challenged to maintain it. Seamus is widely seen as a talented executive. But will he attempt to write Fabrinet’s next chapter with — or without — the team Mitchell put in place?

Investigation at Fabrinet

Weirdness abounds at Fabrinet. Consider the following:

On Aug. 1, CEO David Mitchell sells 40,000 shares of company stock in a transaction valued at $734,000.

On Aug. 12, JDS Uniphase lowers its outlook, saying its current quarter sales will be as much as 8% lower than the consensus analyst forecast. JDS is Fabrinet’s largest customer, and one of two 10%-plus customers of the EMS firm.

Today Fabrinet announces it will postpone its fourth-quarter earnings release in the wake of an internal investigation into “certain accounting issues” uncovered by company management during its most recent fiscal quarter. The firm says it is also looking into whether there may be any “deficiencies” with its disclosure controls and procedures.

There’s no obvious straight line here. I’m hoping the timing of Mitchell’s transaction was just good luck, and that the investigation isn’t related to any insider shenanigans. Based on similar announcements from other industry companies, the investigation has something to do with the company’s inventory management. Such tightly sequenced events bear further watching, however.


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.

Thai Wage Rate Offers Financial Food for Thought

China isn’t the only Southeast Asia nation struggling to come to grips with rapidly increasing wages.

Thailand’s government is considering a 21% hike in the minimum wage, leading several executives to warn that the move could push labor-intensive jobs elsewhere.

Thailand is home to several of the world’s largest EMS firms, including Cal-Comp (no. 8 on the CIRCUITS ASSEMBLY Top 50), Team Precision (n0. 19), Delta Electronics, Hana Microelectronics ( no. 29) and SVI Public Co., not to mention Fabrinet, which is based in San Francisco but whose factories are in Thailand.

We will hear more and more of this as Asia faces the same, inevitable swell of worker pushback. Thailand suffers through massive worker strikes each year, and its government may finally be capitulating. With higher wages come increased overhead, although it would take far more study and space than allowed here to examine whether the expenses related to training, turnover and (lower) end-product quality exceed those of a higher minimum wage.

What we do know, however, is that much of the world’s economic model balances on the import economies of the US and Europe. Over time, this will have to change, lest we continue to endure sharp boom-bust cycles every few years.

EMS, On the Move

InForum analyst Eric Miscoll today asks, Is the migration of electronics manufacturing to Asia slowing?

An excellent question.

And Eric points out some compelling data for why manufacturers might be reconsidering their choice of geography, including substantial hikes over the past 30-plus months in the average, non-weighted cost of fully burdened labor in China: over 50% for board assemblies and over 100% for box-build. Eric also correctly points out that OEMs have taken a certain amount of builds back in-house. (Alcatel-Lucent and Nokia are two widely noted examples.)

But it’s his next comment – almost a throwaway line – that caught my attention: “[T]he pursuit of the next low-cost region continues, with countries like India, Vietnam, Ukraine, Tunisia, and Macedonia garnering the attention of the industry.”

That’s frightful. The Ukraine has a host of roadblocks, not the least of which its much-publicized battles with Russia and general political instability. Vietnam has been oversold; after nearly a decade of temptation, it has simply failed to take hold as an EMS hub. And while the CIRCUITS ASSEMBLY EMS Directory finds that two major EMS companies – Zollner, the world’s 12th largest EMS company (and largest privately held one), and LaCroix have factories in Tunisia – the nation’s population is just 10.3 million, not enough to accommodate a wave of production. Macedonia is even smaller: 2.1 million. Moreover, it is surrounded by mountains that make it difficult to move product to other locales.

Thailand, on the other hand, doesn’t garner much ink, but in my opinion stands as a far more attractive area, with a population of 63 million, relative political stability, the experience of major EMS companies (Cal-Comp and Fabrinet, among others), a cadre of local English speakers, and the attraction of Bangkok.

And, it says here, the food’s darn good too. For some reason, that’s always ignored.