Sanmina Bucks the Electronics Tide

Jul 16 2001

Wall Street gave a thumbs-down to outsourcing company Sanmina's $4.5 billion purchase of rival SCI on Monday, and on the face of it, it's not hard to see why.

Shares of Sanmina lost nearly 11 percent of their value as investors worried that the deal was difficult to justify given the dismal results lately in the contract-manufacturing sector. Contract manufacturers, also known as EMS companies, build much of the gear sold by big computer makers and telecommunications equipment companies. Contract manufacturers such as Sanmina, Flextronics and Solectron hit a wall in this year's downturn after a period of rapid growth.

Contract-manufacturing plants – many of them located in Mexico, Central Europe and Asia – are running at about 40 percent capacity, and Sanmina announced plans just last month to shutter some of its facilities. The big customers for outsourcers, including Cisco, Nortel, Lucent and Motorola, are experiencing one of the worst tech declines in history. Sanmina, which reports its quarterly results on Wednesday, is expected to show a drop in revenues over the past three months of as much as 40 percent. All in all, that makes it a strange time to make a major acquisition – one that entails the assumption of $1.5 billion in debt, to boot.

But those fears mask the expected strength of the contract-manufacturing business during the next few years. U.S. electronics companies are expected to outsource a growing portion of their manufacturing over the next decade. That means that even if demand remains flat for PCs, routers and switches, revenue for the outsourcers could grow strongly.

A recent survey of 150 electronics companies conducted by financial services company Bear Stearns showed that brand-name companies intend to sharply increase the percentage of their products outsourced to companies such as Sanmina and Flextronics. The average PC-maker plans to outsource around 73 percent of its total manufacturing in the next few years – more than five times the industry average today. Fully 40 percent of those companies plan to off-load virtually all of their manufacturing, becoming essentially R&D, design and marketing companies. Such a move to "virtual manufacturing" would mark a huge shift in the electronics industry and would translate into renewed rapid growth for the contract manufacturers.

"Regardless of what happens in terms of end-market demand for electronics products," Bear Stearns managing director Thomas Hopkins said when the survey was released in May, "contract manufacturers should see an increase in their business."

Argus Research analyst James Kelleher, who follows the contract-manufacturing industry, says he expects the sector to return to growth rates of 50 percent to 70 percent a year – as early as next year. And it's not just the volume of business being shipped off to outsourcers, it's the kind of business. A deal that Flextronics signed with Ericsson last January marked an epochal change in the way electronic products are built. Under the $1 billion contract, Flextronics will not just assemble Ericsson's handsets, but will assume the entire operation, from design to finished product. Big contract manufacturers have spent the past few years buying design firms and establishing their own supply chains, building for just such a shift.

Seen in that light, the SCI purchase makes much more sense for Sanmina: The San Jose, Calif.-based outsourcer gets an expertise in PCs that it lacked plus the size and heft to continue diversifying as the outsourcing movement gathers steam. The merged company would have more than $14 billion in annual revenue, with about 100 plants in 20 countries worldwide. That reach leaves Sanmina well-positioned to grab some of the huge outsourcing contracts that are sure to come up in the next 18 months – regardless of how the economy fares.