Fertile environment for EMS players to capture new business opportunities. Separating chairman and CEO roles. Balance sheets as selling points with OEMs. Emerging opportunities in clean technology, renewable energy.
As of the posting of this exclusive VentureOutsource.com interview, the electronics manufacturing services (EMS) sector’s most up to date market value is estimated at $233 billion for 2009 (with an annual growth rate of -16.9% compared to 2008) according to leading market research firm IDC.
Contract EMS providers build product and provide supply chain services for technology OEM companies in this worldwide market serving such segments as consumer electronics; PC and computing, servers and networking equipment, semiconductor capital equipment and industrial electronics, medical electronics, defense and aerospace electronics and many other market sectors plus, various new emerging markets.
VentureOutsource.com talks with Sean K. F. Hannan, vice president and senior analyst, equity research, for the EMS sector at Needham & Co. (www.needhamco.com) where he provides varying types of analysis, financial outlooks and public stock recommendations. Hannan’s EMS universe, where Needham & Co. makes markets (see disclaimer end of interview) includes coverage of Flextronics (Nasdaq: FLEX); Sanmina-SCI (Nasdaq: SANM) and Plexus (Nasdaq: PLXS).
As part of Hannan’s responsibilities and additional interests, he also tracks and monitors other EMS providers and various leading technology OEM and electronics components companies.
Mr. Hannan responds to questions with insightful and smart commentary – discussing industry and EMS company-specific value propositions; EMS provider strengths and challenges, EMS trends on the horizon, fourth quarter 2009 EMS industry demand, and more.
VentureOutsource.com: How do you see tier-1 electronics manufacturing services (EMS) providers competing differently with each other during this recovery?
Hannan: Aggressive pricing seems to be used much less than it has in the past. Some EMS companies are using their balance sheet as a selling point to emphasize continuity and long term relationships with OEM customers.
A few EMS companies have entered ‘defense’ mode where the focus is now on core competencies to protect core markets, while others (i.e., Jabil) have made a larger push to expand and build new relationships in emerging, non-traditional markets like renewable energy and smart grid technologies.
VentureOutsource.com: Results from our summer electronics supply chain survey showed some EMS segments more optimistic than others but other market areas in the supply chain still lagging. When do you see a broad-based recovery happening for the EMS industry, overall? What ‘signs’ should we be looking for?
Hannan: I believe the groundwork is already being laid today in two ways.
First, the recent downturn established a very fertile environment for EMS players to capture new business opportunities. Let’s not forget that bringing products to market and establishing successful brands remain critical functions of OEMs. The nuances of manufacturing and supply chain management can become a distraction in some instances, and this is where the strengths of EMS companies can provide relief to OEMs that wish to truly streamline their operations in the new ‘normal’ environment. We’re starting to hear EMS management teams qualitatively discuss new business and bid activity while reported backlogs are either poised to grow or are growing.
Second, the underlying environment has largely stabilized and we’re seeing that in elements of inventory replenishment as well as through commentary throughout technology hardware leaders.
VentureOutsource.com: What are your thougths about Jabil Circuit (NYSE: JBL) exiting its automotive electronics business? What additional challenges do you see Jabil facing?
Hannan: I’m pleased to see the decision. Automotive has been viewed as a growth opportunity for the EMS industry for many years now, but the promise has never delivered due more to the dynamics of the auto industry. Even with Jabil holding a fair share that has probably been in the low-to-mid teens range, the company was never able to be as successful with this business as it had hoped.
I’d expect Jabil’s peripherals business segment to continue to see some headwinds due to a sizeable Hewlett-Packard printer business that appears to be holding back the positive momentum in set-top boxes. This space doesn’t seem to be showing great recovery prospects in the near-term, but the dynamics are probably more of a temporary problem.
Additionally, displays clearly aren’t a segment that will help, but this business has become very marginalized.
VentureOutsource.com: What are your thoughts on Flextronics’ current value proposition relative to its peers? In your eyes, is Foxconn a better EMS provider than Flextronics?
Hannan: Flextronics has clearly committed to the scale and volume tactic through a vertical model, and it bolstered this approach by acquiring Solectron and building complementary capabilities. Flextronics’ strategy is not going to be focused on the higher complexity / low volume EMS work we see in aspects of medical or a lot of security, defense and aerospace. But, I believe Flextronics’ value proposition is quite sound for the markets it addresses as the company has become a viable competitor to Foxconn in this regard.
It would be difficult to argue today that Foxconn has been unseated as ‘top dog’ by Flextronics. But, that question could become more relevant in a few years.
VentureOutsource.com: What changes would you like to see at Flextronics?
Hannan: I’d like to see Flextronics streamline some of its vertical capabilities a little better. I suspect more production could go to Asia from higher cost geographies such as Germany if the production complexity can be properly managed. I’d also encourage Flextronics to be mindful of its evolving margin profile and avoid the slippery slope of creeping beyond notebooks into the lower average selling price (ASP) netbook business.
VentureOutsource.com: Sanmina-SCI has been trying to re-invent itself the past couple of years but seems to be having some difficulty developing a cohesive corporate strategy. Which obstacles must the Company overcome for its strategy roadmap to finally take shape and gain some traction?
Hannan: Sanmina-SCI must establish a stronger identity in terms of its role in the markets it serves; today, many view Sanmina as straddling the fence between volume and higher complexity mix.
Also, Sanmina’s commitment to a vertical strategy needs to start making more sense and become additive to the business overall.
Before the downturn, Sanmina’s operations already had disappointing results (in a healthier environment) and seemed to foster poor quality (low-margin) program wins for the broader Company. Sanmina management has made a lot of changes and improvements to these operations, but the level of effectiveness may be difficult to see in the near-term.
VentureOutsource.com: Jure Sola holds both chairman and CEO titles at Sanmina-SCI. What are your thoughts on Sanmina-SCI not having an independent board chairman whereby the CEO would then be accountable to a board chaired by an independent director? Some (hopefully positive) strategic decisions have been made by the Company lately but might the current setup of the board prevent truly open discussion with dissenting opinion, or perhaps even constructive criticism, from taking place at the Company’s highest level?
Hannan: Fundamentally, I’m a believer in separating the chairman and CEO roles. I suspect the lack of this separation has probably hurt more than it has helped at Sanmina, particularly entering the downturn when the company then lost its CFO, David White, to another industry. However, Jure is a passionate leader, and he now appears to be making some progress in weathering the storm.
VentureOutsource.com: What challenges do you see facing Plexus? What changes would you like to see at Plexus?
Hannan: Plexus’ medical segment had been a very positive contributor for a long period, but it is now facing a saturated imaging market with less favorable legislation.
This challenge isn’t going away anytime soon and will likely overshadow other areas of medical until they become larger in scale. I believe Plexus may also run into challenges in ramping mechatronics in the near-term.
Mechatronics is a more complex service that doesn’t have much history for outsourcing to EMS providers. While Plexus does have some experience with smaller mechatronics programs, embracement by OEMs beyond Coca-Cola may take time. (See more on Plexus’ Coca-Cola mechatronics program win)
Additionally, Plexus’ Juarez facility in Mexico has been a headwind for a number of years, and Plexus needs to either continue bringing in new programs and build its business or investigate strategic alternatives to this specific near-shore location.
Over time, I’d like to see Plexus to continue to diversify its customer base in networking. Juniper has served as a great anchor customer, but it remains a high concentration at 23%.
VentureOutsource.com: Looking at the following EMS providers: Flextronics, Jabil, Sanmina-SCI, Benchmark Electronics (NYSE: BHE), Celestica (NYSE: CLS) and Plexus; who do you feel is best at managing their medical electronics business, and why?
Hannan: I have the most favorable view of the medical business at Plexus. This is a segment where the company has demonstrated the ability to deliver high complexity solutions in addition to creating strong customer relationships and brand.
VentureOutsource.com: What challenges do you see facing Benchmark Electronics? What changes would you like to see at Benchmark?
Hannan: One of the main challenges I see at Benchmark is the company still has a very high concentration of business in high-end computing (~38% of total revenues as of June). Enterprise computing has become a fairly mature and well-penetrated space, so growth becomes increasingly more dependent on the revenues in the underlying market as opposed to entirely new OEM outsourcing opportunities.
Also, Oracle’s acquisition of Sun Microsystems adds a layer of ambiguity to the Sun business. This customer has become much less meaningful than prior years but remains notable at just under 10% of Benchmark’s revenues.
I’d like to see Benchmark make stronger progress in its non-traditional markets such as medical and industrial. The key to growing these groups could be rooted in getting better leverage from the engineering capabilities acquired through its acquisition of Pemstar and providing a more meaningful feeder and incubator business for programs down the road.
VentureOutsource.com: Can you discuss three (3) trends you see emerging in the EMS industry?
Hannan: The first trend I see taking place is renewed interest in the value proposition of EMS services, particularly in non-traditional markets. Many OEMs are still working toward understanding today’s ‘new’ demand environment (post-crisis) while outsourced manufacturing and supply chain management can offer greater appeal through a more variable model. Most of the larger well-established EMS companies should benefit from this trend.
Another trend I see is that the big get bigger and the smaller companies become further specialized. Good examples in this case would be Flextronics and Plexus with regards to volume and mix.
I also see sub-spaces such as renewable energy and smart grid technologies becoming more meaningful to industrial segment-level operations. Utility meter technologies (particularly automated meter reading, or ‘AMR’) have been outsourced for years to the EMS industry, and this segment is now seeing a transition to more complex advanced meter infrastructure (or, ‘AMI’) products that should experience a sharper demand and adoption curve.
Additionally, the solar industry has now had some momentum for a few years, but solution outsourcing to the EMS industry remains in the early stages.
Today, Jabil appears to be the most visible and well positioned EMS provider for these trends as the company already has relationships with many of the meter vendors and is gaining ground with solar partnerships.
VentureOutsource.com: How do you see EMS end-demand coming in for Q4 2009?
Hannan: I expect that most segments in EMS should see some return of seasonality. The consumer does not seem to be particularly robust, but it certainly hasn’t disappeared as much as many had feared earlier in the year.
Further, the environment for enterprise spending appears to be showing signs of life in most areas (other than the client side) as some corporate budgets are exploring possibilities of coming out of basic ‘lights-on’ mode to address needed maintenance and selective projects once again.
VentureOutsource.com: Any other comments you want to share with readers?
Hannan: The demand environment in 2010 may become much more interesting than how we exit 2009, particularly in the traditional computing markets.
On top of some elements of broader recovery, which I’d expect to continue over 2009 at a low-to-moderate pace, the release of Windows 7 should help to drive upgrades to aging hardware (perhaps change in PC sector market share) on the client and enterprise side.
Disclaimer: Needham & Co. does and seeks to do business with companies covered in this industry interview. Investors should be aware the firm may have a conflict of interest that could affect the objectivity of the responses in this interview. Readers should consider responses in this interview as only a single factor if any investment decisions are being made.
VentureOutsource.com, October 2009
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