Reading tea leaves for top EMS providers

December 2007

A recent report by Deutsche Bank Equity Research analyst Sherri Scribner details some emerging themes in the electronics manufacturing services (EMS) market as investors and OEM company executives continue to try and differentiate supply chain outsourcing providers in the hyper-competitive EMS industry.

The report follows Deutsche Bank's recent move as the investment bank resumes coverage of EMS providers Flextronics, Sanmina-SCI, Celestica and Jabil Circuit. The report also includes information on the electronics contract manufacturing industry leader Hon Hai. Some points of interest cited in the report follow and include:

EMS restructurings
Operations shifting to low-cost locations
EMS vs. ODM business models
Hon Hai market share driving EMS industry growth
Financial metrics comparisons

Publisher's note: ‘Deutsche Ban', displays on some images. All image content provided by Deutsche Bank.

EMS restructurings

All four of the EMS companies Deutsche Bank is resuming coverage on are currently undergoing some type of restructuring.

Flextronics is in the middle of integrating the Solectron acquisition. The company expects to incur $430M to $500M in restructuring charges, and spend $500M to $550M in cash as part of its integration plan. Jabil is in the middle of a restructuring and rationalization plan that started in F4Q06. The company plans to incur roughly $250M of restructuring charges and spend $100M to $250M in cash to take high-cost manufacturing out of Western Europe.

Sanmina-SCI is also in the process of restructuring to return its business strategy to its original model which focused on the high-end market. Sanmina-SCI plans to sell its underperforming PC business, to focus on better cash conversion of its balance sheet, and to improve margins of its components businesses. The company took $45M in restructuring charges in FY07 and plans to take an additional $75M to $85M over the next six months for further plant closures and realignments.

Celestica is also currently restructuring its business, and has another $27M to take in restructuring charges before mid-2008 to turn around its Mexico and European operations, which are currently operating at a loss. The restructuring theme is not new, with many of these companies taking restructuring charges after the bursting of the tech bubble. Flextronics has taken restructuring charges each year since FY01 for some type of restructuring, spending nearly $3B during this period.

Jabil took restructuring charges of $165M in FY01 through FY03 to realign its business after the tech bubble burst. Sanmina-SCI has taken nearly $1B in restructuring charges since FY01 to improve its business model, while Celestica has taken over $2B in other charges to realign its business model. These charges suggest that the industry is plagued by chronic restructuring actions.

Figure 1: GAAP Operating Margins

Deutsche Bank believes the realignments are often necessary and important, the frequency of these changes suggests that they are an ongoing cost of doing business as an EMS firm. As a result, Deutsche Bank believes that generally accepted accounting principles (GAAP) operating income, as opposed to non-GAAP operating income, is more indicative of results over time.