Dissecting the new Flextronics

Flextronics company profile

Flextronics is the second largest electronics manufacturing services (EMS) provider in the world, with its second place position secured in October 2007 through the purchase of EMS industry competitor Solectron. Flextronics' major markets include computer, mobile phones, consumer electronics, industrial electronics, automotive electronics, aerospace electronics, marine, telecommunications and medical electronics and devices.

In FY07, Flextronics' largest segment was mobile phones, which accounted for over 30% of revenue. With the acquisition of Solectron, Flextronics' largest segment will be infrastructure, with roughly 30% of revenue generated in this segment. Flextronics' major customers include Casio, Cisco, Dell, Kodak, Sony-Ericsson, Hewlett-Packard, Kyocera, Microsoft, Motorola, Nortel, and Xerox.

The Solectron acquisition adds IBM, Lucent, NEC, Thomson, and Teradyne. The combined company will operate roughly 24.2M square feet of manufacturing facilities located worldwide with more than 192,500 employees. Flextronics is incorporated in Singapore and has its U.S. headquarters in San Jose, California.

Recent analysis from Deutsche Bank Equity Research evaluates the ‘new' Flextronics as the company integrates Solectron into Flextronics' growing global footprint. According to Deutsche Bank Equity Research, with some interpretation from VentureOutsource.com, Flextronics has been a consistent executor, with above-average margins and the best balance sheet management in the EMS industry.

Flextronics is seeing rapid growth in new markets such as mobile phones and emerging segments, and is now targeting notebooks as a growth opportunity. Deutsche Bank favors Flextronics' recent Solectron acquisition as it adds diversity to Flextronics' revenue base and the firm believes Flextronics will be successful in applying its low-cost model to Solectron's business.

Flextronics already has a solid presence in the mobile phone market, and has now announced plans to target the notebook segment with its acquisition of Arima's notebook PC and server assets. The notebook market has seen strong growth in recent years, up 21% in 2005, 17% in 2006, and forecasted to be up 21% in 2007. Deutsche Bank believes Flextronics' success in the mobile phone segment, and the acquisition of Arima, position the company well to compete in the notebook market.

Deutsche Bank believes Flextronics had two objectives for purchasing Solectron:

1. taking capacity out of the industry, and
2. amassing Flextronics' scale to match Hon Hai, the current market share leader in the EMS space.

Hon Hai also has 20% share in the computing segment where Flextronics is targeting growth in notebooks.

Flextronics, EMS industry risks

EMS stocks have historically been volatile due to the high fixed cost nature of the business which leads to significant swings in profitability. In addition, the industry is also dependent on OEM sales, which is driven by the health of the overall macroeconomic environment.

In Flextronics' case, company-specific risks include difficulty in integrating the Solectron acquisition, an inability to return to previous operating margins due to the Solectron acquisition, the loss of a significant customer such as Sony-Ericsson, and a faster-than expected decline in the global economy.

Flextronics acquiring scale to match Hon Hai

As mentioned above, Deutsche Bank believes Flextronics had two reasons for acquiring Solectron: (1) taking capacity out of the industry, and (2) amassing scale to match Hon Hai.

Hon Hai is currently the market leader in the EMS space with 25% market share in 2006 (Foxconn plus Foxconn International Holdings in Figure 1).

Hon Hai has grown revenue 45% in 2006 and is expected to grow roughly 30% annually over the next two years. A significant portion of this growth is due to Hon Hai's strong position in the mobile phone and notebook markets. As seen in Figure 2, more than 90% of the company's revenue comes from consumer devices (mobile phones and flat panel TVs), and computers. In addition, Hon Hai has benefited from OEM relationships with Apple and HP, both of which are gaining share in the PC market.

While Deutsche Bank believes Flextronics is not specifically targeting Hon Hai, Flextronics will begin to see Hon Hai as a competitor in more engagements as Flextronics moves into Hon Hai's core computing and consumer device markets. Meanwhile, it could be reasonable to expect Flextronics to be more successful at taking share from smaller original design manufacturing (ODM) notebook providers as Flextronics ramps up its offerings.

    

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