Meanwhile, Celestica poured millions of dollars in the June quarter into ramping production for solar lines in Asia. Speaking to analysts on July 23, CFO Darren Myers said, “[W]e think there is a lot of exciting opportunities for us within solar.”
It was just five years ago when the solar industry was growing like gangbusters, fueled by massive government investments and incentives. Then came the crash in 2012, which prompted some conglomerates to offload units (read: Dover) that had become dependent on those markets.
Fascinating how aggressive Natel Engineering has been with acquisitions over the past 18 months. First it gobbled up Epic, and this week it announced plans to nab OnCore. Epic was roughly 2.5 times the size of Natel at the time of that deal, and OnCore is almost the same size as Natel is now. Combined, they will form an EMS business with pro forma revenues of $770 million, 13 manufacturing sites and more than 3,700 employees.
And to think that as recently as September 2013, Natel had sales of $100 million spread across three factories, some of which were hybrid thick film, not SMT. That’s a stunning transition.
Can it hold? This latest deal is highly leveraged, and Moody’s gave Natel a B2 CFR rating, (obligations rated B are considered speculative and are subject to high credit risk; the 2 refers to mid-range) and a B1 LGD3 (loss given default) assessment (meaning ?30% and <50%, in Moody’s opinion). After the close, Natel will end up with $340 million in debt, between the new lender and a $60 million note issued by OnCore’s owner, Charlesbank Capital.
We’ve seen huge runups in the past, sponsored by equity capital, that have burst into flames because the market couldn’t provide the necessary growth to sustain the acquirer’s debt payments. Viasystems is perhaps the most notorious example; that company ended up going through bankruptcy before finally stabilizing and operating in somewhat lower-key manner up until its announced acquisition by TTM Technologies last year. Flextronics went through one major flameout in 1990 before reappearing as a Singaporean company. Of the CIRCUITS ASSEMBLY Top 50 however, today most are few of undue private equity influence.
For those wondering what EMS or PCB companies might be veering toward financial distress, here’s an interesting tool. I’m guessing Jabil ranks relatively highly on this because of its high exposure to Apple. Companies also seem to be penalized for a high P-E ratio.
The findings of a new study by Boston Consulting Group suggest that, over time, many tech companies are guilty of mission-creep, especially large ones. And when that happens, those companies do not provide the shareholder value they could if they were leaner and more focused.
As part of its study, BCG analyzed total shareholder return, defined as the bottom-line return from capital gains and cash flow contribution. When it did so, it found little distinction between large-cap and small-cap companies:
“The clear takeaway is that regardless of company size, the more diverse the portfolio, the more difficult it is to generate high TSR—and the greater the set of management skills a company needs in order to handle that diversity. Companies must therefore be more deliberate and more explicit in rationalizing each element of their portfolio.”
BCG likens the strategy to the 3 R’s, in this case, Resize, Reform and Rejuvenate. Marc Andreessen, the founder of Mosaic (later Netscape), put it this way: “If they’re more than 20 years old, then [companies will] probably benefit from being broken up, and many of them will probably be forced to break up if they don’t do it voluntarily.”
So for the EMS pseudo-conglomerates (Foxconn, Flextronics, Sanmina, etc.), what this means is there are arguments to be made — indeed, being made — that having bare boards, assemblies, design services, box build, ODM products, and a host of other products and services under a single umbrella is not an optimal strategy.
There’s always been some debate over whether publicly traded EMS firms should be compared to other tech firms like Cisco and Microsoft or to traditional manufacturing companies (say, Caterpillar). It’s tough for a mid-size or larger contract manufacturer to attain repeated organic double-digit topline growth, and their margins are never going to be Wall Street pretty. Dumbing down the peer group makes sense.
But the bigger question being asked is whether their size is actually a hindrance. There must be a point at which that happens. Can the data analysis pinpoint that yet? And will market impatience make all of this moot?
In the end, Microsoft couldn’t pull the trigger. In Seattle, outside just wasn’t “in.”
The world’s largest software developer today named Satya Nadella, head of the the company’s Server and Tools unit, as its new chief executive. The 46-year-old Nadella becomes just the third person to lead Microsoft, one of the most successful and wealthiest companies ever.
So when John Thompson, Microsoft’s new chairman, says, “Satya is clearly the best person to lead Microsoft,” one wonders why it took so long for them to recognize it. Perhaps they had to go through the rituals before realizing the prettiest date was the one they already live with.
In opting for Nadella, Microsoft eschewed calls to go outside for an executive who might shake up its culture or sell of pieces to boost its share price. Like Intel, it chose continuity and engineering prowess over salesmanship and the flavor of the day.
My take is Microsoft’s culture isn’t the problem; it’s been the top management’s inability to establish the proper hierarchy to allow the brilliance of the company’s thousands of engineers to come through. Time and again, Microsoft has had great ideas on the drawing board, but been beaten to market by competitors that simply execute much faster (read: Apple). Under Nadella, that will have to change.
Clearly Nadella understands how hardware can drive software purchases. As head of Microsoft’s Server and Tools business, he led a $19 billion, 10,000-employee entity that is front and center in the world of cloud computing. As he told Venture Beat in an interview last May, “We broadly as a company are moving from a software company to a devices and services company, and that’s really the transformation, both in terms of technology and delivery – as well as business model. What I do, what our division does is very central to this.”
Given his knowledge of the hardware supply chain, we are eager to see whether Nadella sees value in pulling manufacturing in-house. Such a move could demonstrably alter the EMS landscape for years to come, not because Microsoft is a dominant customer of any of the major contract assemblers — Flextronics builds the Xbox, but none of the Top Tier EMS firms counts Microsoft at a 10% or more client — but because OEMs have a herd mentality and if it works for Microsoft, they will likely follow.
Thanks to the roughly $100 billion in cash Microsoft has on hand, Nadella will have the resources to get wherever he wants to go, and, with Steve Ballmer retiring and Bill Gates stepping down as chairman, he will have full authority to make the tough decisions without the specter of the founders looming over his shoulder. Those two decisions — cofounder Paul Allen stepped aside years ago and is now seen rocking out at Super Bowl parties for the Seattle Seahawks, which he owns — should not be downplayed, as Nadella will not only need the financial backing but the unmitigated authority to make Microsoft as successful in next three decades as it was in the last three.
The EMS company’s management this week acknowledged an ongoing restructuring — to the tune of $188 million in charges — but declined to address specific actions. “We intend to realign our manufacturing capacity and cost base to appropriately size our manufacturing footprint with current market conditions and our customers’ geographic needs. We have begun consultation with employees during the third fiscal quarter and out of respect for those employees, we shall not be providing details as to specific sites or locations under consideration at this time.”
Under repeated questioning from analysts on a conference call, CFO Forbes Alexandar did suggest that the restructuring would include plant closures. Discussing when the charges would hit, he said, “[I]t’s really to do with the timing of when we can, essentially, start closing sites or releasing employees and transferring business.”
Obviously, this information will come out, likely sooner rather than later. But it can’t help that while Jabil is trimming, Flextronics’ shuttering of several sites this year has been effectively drowned out by the announcement of a massive new operation outside of Dallas, where it will build the new Moto X smartphone. Jabil also does business with Google (which owns the former Motorola handset business), but my understanding is these tend to be prototypes, while Google performs the volume and final assembly in Fremont, CA.
Notebook ODMs, faced with falling demand and profits, are not going gently into the good night. Flextronics dumped the PC ODM business a couple years ago to concentrate on higher margin, higher growth markets. Sanmina did the same. Now Wistron is pushing into medical as well. Others are sure to follow.
Onshoring has become the word of the moment, the expression of hope, the exposure of wishful thinking to those who try to intepret relatively small onshoring activities as major moves for job and economic recovery.
Flextronics CEO Mike McNamara pointed out in an interview with Larry Dignan of ZDNet, “As you see things that get pushed back into the US, “a la” the (recent) Apple comment it is more than just having the right cost structure. You also have to design for more automation and more different kinds of productivity. So, it is an evolution; it is not just flipping a switch. You actually have to spend a lot of work in the design, all the way through to the manufacturing process, knowing where you are going to manufacture. I think it is going to take time.”
It will not only take time, it will take incentives from the government. If Taiwan can do it, why can’t America do it? A major lure could be the lowering of one of the world’s highest corporate tax rates. Another would be to remove or simplify many of the “make-do” reporting procedures and requirements that seem to do nothing but tie a company’s hands, increase costs, and create more public sector jobs.
Taiwan’s new reinvestment incentives began last month, with an aggressive goal of more than doubling the returning investment from overseas Taiwanese businesses to $6.89 billion over the next two years. Companies need to meet certain requirements, such as producing critical components or marketing products under their own brand. Taiwan’s government announced on Dec. 6 that Catcher Technology and Largan Precision will invest in new factories in Taiwan that will create some 3,800 jobs over the next few years.
Even the most pessimistic industry-watchers should be curious at least over the shifting attitudes toward bringing production back to the US.
The New York Timestoday published an extensive piece looking at the top-down change — from President Obama on down — in the nation’s outlook toward manufacturing. Researchers at MIT and elsewhere are promoting the benefits of keeping makers and thinkers together. “The manufacturing process itself is going through an innovation revolution,” said Stephen Hoover, chief executive of Xerox PARC, noting the emphasis on smaller numbers of highly skilled techs who run sophisticated and heavily automated lines.
Earlier this week, Mike McNamara told listeners at an investment conference that higher (and unabating) labor costs in Southeast Asia is making the decision process over where to put its plants “more interesting.” The Flextronics chief executive said he could see production coming back to the US. “[O]ver time, as [labor] costs continue to go up, you’ll probably see more things get pushed back in the USA,” McNamara said.
Even Foxconn is showing some appeal (for a change) for its push toward automating its factories. Maybe Jim Raby’s vision for true lights-out manufacturing will finally be realized?
A decade ago, at Wall Street’s urging, companies followed the herd to China. Not enough thought was given to the ramifications of chasing lower labor costs, and my guess is that we will be feeling the pain of these short-sighted decisions for some time to come.
But given the prospects for higher levels of automation and a more balanced approach to regionalization, it’s been years since the industry was so exciting.
Checking our pool of 30 or so publicly traded EMS companies that have thus far reported third-quarter earnings, we see an industry that is decidedly mixed.
Exactly half of those in our pool reported net income rose over last year. And 16 said sales are higher.
Of the Tier 1s, Foxconn and Jabil said sales were up, and Foxconn and Flextronics saw higher profits. Celestica and Sanmina-SCI saw revenues fall while Plexus’ and Benchmark’s rose. However, all but Sanmina took profit hits.
The mid tier EMS groups were no easier to divine. On the larger side, Nam Tai and IMI had great quarters all around, Kimball saw operating profits and sales climb, and Venture’s sales ticked up too (it hasn’t reported profits yet), but Fabrinet (whose recovery continues) saw both figures slip. Key Tronic was up, CTS was down. Scanfil was up, Note was down. Neways was up, PartnerTech was down.
You get the idea.
The good news is, most companies, especially the larger ones, saw higher revenues in the third quarter than they did in the first. This could be another sign that the traditional seasonality has returned, which would be welcome at least because it makes things a little more predictable.
In listening to the various analyst calls and poring over the quarterly reports, it seems many companies reaped the benefit of existing programs in the September period, while those who didn’t were plagued mostly by new product starts, which are a drag on earnings. The former could hide some deeper some concerns, because all programs eventually come to an end, and if overall launches are on the decline, it could spell trouble down the road. This could be why several EMS companies, which collectively tend to be a bit gunshy bunch anyway, warned that the December quarter might be slower than the last.