MMI May 2006
Vol. 16, No. 5: May 2006
Gulf Widens Between EMS and ODM Growth in Top 25
Sales of Top 25 outsourcing providers pass $167 Billion
EMS providers want to believe that the growth of the EMS business will eventually match that of the ODM sector. Otherwise, the EMS industry will continue to lose market share in the outsourcing space to ODMs. EMS backers hope that ODM growth rates, often viewed as unsustainable, will head downward toward EMS rates. But based on 2005 results of the 25 largest providers in outsourcing as identified by MMI, there’s no evidence that growth rates of the two sectors are converging. In fact, just the opposite happened in 2005.
MMI compared aggregate 2005 sales growth of the 13 EMS providers in the top 25 versus growth of the 12 ODMs. Annual revenue growth of the ODM group reached 34.3% in 2005, 19 percentage points above the 15.1% increase generated by the EMS group (see chart below). Although data from the 2004 version of the top 25 indicated that the gap between ODM and EMS growth had narrowed in 2004, 2005 results show that this trend has reversed. The 19-point growth gap in 2005 is basically double the nine-point difference computed for 24 companies in the 2004 top 25. (See May 2005, p. 3. Sales growth was unavailable for one company.)
What happened in 2005? ODM growth remained high from 2004 through 2005, while the EMS side lost some momentum in 2005.
Moreover, the latest quarterly results from a similar group of 25 publicly held providers (15 EMS providers, 10 ODMs) confirm that the gulf between the two groups remains wide (see next article).
Heading toward $200 billion
The outsourcing business in electronics manufacturing will never again see $100 billion in annual sales. It’s far too big for that now. The 25 largest providers in outsourcing, as identified by MMI, combined for $167.3 billion in sales last year. Aggregate sales in 2005 increased by $30.7 billion, or 22.4%, over the prior year. Although this growth rate doesn’t quite measure up to the 28% rise in 2004 sales produced by 24 of the top 25 outsourcing providers for that year (see May 2005, p. 2-3), the 2005 increase demonstrates once again that the outsourcing trend remains robust.
What’s more, if the top 25 providers as a whole continue to grow at last year’s combined rate of 22.4%, they will surpass $200 billion in total sales this year.
MMI compiled its list of the top 25 providers of outsourcing services by ranking companies in order of calendar 2005 sales, as expressed in US dollars (see table at right). It should come as no surprise that Hon Hai Precision Industry, also known by its Foxconn trade name, occupies first place as the largest provider in the top 25. Hon Hai has already claimed a commanding position atop the MMI Top 50™ list of the largest EMS providers (March, p. 2). However, it is unknown how much of Hon Hai’s sales came from OEMs and what portion derived from OBM (original brand manufacturing) sales to the channel.
The top 25 providers in outsourcing constitute what has now become in effect a billion-dollar club. It took a minimum of $944 million in 2005 sales to make MMI’s top 25. In 2004, the cutoff was $726 million.
Top-ten companies all posted sales above $7 billion. There were some changes in the order of the top ten, with two ODMs rising in the standings and three EMS providers moving down. Quanta Computer climbed from fifth position in 2004 to third in 2005, while Asustek went from seventh place to fifth. Dropping in the order were Sanmina-SCI from third to fourth, Solectron from fourth to sixth, and Celestica from sixth to seventh (see table).
The composition of the top 25 remained largely intact from 2004, but the 2005 list contained two companies that did not appear in 2004. Joining the 2005 list were Inventec Appliances and Arima Communications, both cell-phone ODMs. They illustrate the trend among ODMs to diversify beyond the PC industry. The two companies are spinoffs from Inventec and Arima Computer respectively, both known as ODM suppliers of notebooks. Gone from the 2005 list were Delta Electronics, which was reclassified as a component supplier, and PEMSTAR, which did not make the 2005 cutoff. As a result of these changes, ODMs increased their numbers in the 2005 top 25 to 12 members from 11 in 2004.
This gain in ODM membership coupled with higher overall growth for the ODM side resulted in an increase in the ODM share of top 25 sales for 2005. ODMs accounted for 42.0% of top 25 sales in 2005, up from 37.4% in the prior year. At 58.0% of sales, EMS providers still represent a majority of top 25 revenue (see chart below).
Although ODMs took top 25 market share from EMS providers, growth rates within both groups varied quite a bit. On the ODM side, top-line performance in 2005 ranged from growth of 109% to a decline of 9% in US dollars. (Growth rates in Taiwan dollars, the reporting currency of Taiwanese ODMs, on the average were about five percentage points below rates in US dollars due to currency conversions.) Among EMS providers, annual revenue changes ranged from up 75% to down 12%.
Editor’s note: This analysis does not provide a true summary of ODM or EMS sales. At least eight providers in the top 25 utilize hybrid business models (see table), by which they operate as neither pure ODMs nor pure EMS providers. For example, in the case of four ODMs that also sell own-brand products, the OBM percentage of their sales is not readily available, if at all. Providers with hybrid models were categorized as ODM or EMS in accordance with what MMI sees as representing the majority of their sales in most, if not all cases. MMI believes that classifying hybrid-type providers in this manner allows one to come up with a useful, if not entirely accurate, measure of EMS and ODM business activity.
Large EMS Providers Off to a Tepid Start in 2006
First-quarter results for 15 large EMS providers, including six companies publicly traded outside the US, show that the EMS business as represented by these providers is off to a slower than desirable start for 2006.
Combined Q1 2006 sales for the 15 large providers increased 6.6% year over year. That’s below the double-digit average growth that most providers like to see. Sales for this EMS group totaled $22.2 billion for the quarter. The 15 large providers consisted of nine US-traded providers, listed in Table 2, and six non-US-traded providers, enumerated in Table 3. Results for the non-US-traded companies were converted to US dollars for this analysis.
When Q1 sales growth for 10 large ODMs is factored in, however, the outsourcing picture turns rosy. In Q1, outsourcing sales for these ODMs plus the 15 large EMS providers totaled $36.2 billion, up a respectable 19.2% from a year earlier.
Q1 sales growth for the nine largest US-traded providers came in at a paltry 1.2% year over year (Table 2), below the combined 6.6% average for the group of 15 providers. Overall growth for the group was propped up by an aggregate sales increase of 17.9% for the non-US traded companies (Table 3). This sales increase can be attributed to the world’s largest EMS company, Hon Hai Precision Industry, which easily posted the highest Q1 sales growth (non-consolidated) among the non-US-traded providers.
First-half growth prospects for the US-traded group of large providers do not appear much brighter, based on estimates incorporating Q2 guidance provided by each company. MMI estimated first-half 2006 sales for each US-traded provider by adding the midpoint of Q2 sales guidance to actual sales for Q1. When combined, estimated first-half sales for the US-traded group yielded a projected growth rate of 2.7% (Table 1 below).
Still, Q1 inventories for the US-traded group were up 6.4% overall from Q4 2005. Providers often build inventory ahead of program ramps.
With regard to profitability, the US-trade group, as whole, has yet to establish a consistently increasing trend line for quarterly net income (see chart below). Combined net income for Q1 2006 came to $80.9 million, down from $188.1 million in Q4 2005 (Table 2). Overall gross margin for the group was 6.0% in Q1, down from 6.2% a year earlier. Group operating margin for Q1 amounted to 1.7% after being in negative territory a year ago.
MMI also tracked seven smaller EMS providers traded in the US (Table 4). On an aggregate basis, their sequential and year-over-year growth rates for Q1 were higher than those recorded for the group of large US-traded providers. These smaller providers together produced sequential and year-over-year increases of 7.0% and 10.8% respectively. Their overall gross and operating margins for Q1 were also better than those of their larger counterparts in the US-traded sector.
How can 25 outsourcing providers together produce Q1 sales growth of 19.2% year over year, when the 15 EMS members of that group only combined for a rate of 6.6%? Ten large Taiwanese ODMs together put up a high enough growth rate to boost overall growth. In Q1 2006, these ten publicly held ODMs accounted for aggregate revenue growth of 47.0% in US dollars (50.7% in NT dollars). (See Tables 5A and 5B.) These Q1 results indicate a continuing disparity between EMS and ODM growth (see chart below
Overall gross margin for the ODM group in Q1 declined to 7.2% from 7.8% a year earlier, while Q1 operating margin increased to 3.6% from 3.3% in the year-ago quarter.
Note: Two ODMs that appeared in the 2005 Top 25 outsourcing providers (see previous article) are not included here. Starting in 2006, BENQ will no longer be classified as an ODM since MMI believes that a majority of its sales now come from own-brand products. Also, non-consolidated quarterly sales of FIC Global were not high enough to be included in this analysis.
Flextronics, Nortel Complete Deal
Top-tier provider Flextronics (Singapore) and Nortel have concluded the final phase of their outsourcing deal worth over $2 billion in annual revenue to Flextronics.
The two companies have completed the transfer of manufacturing operations and related assets of Nortel’s Systems House in Calgary, Canada, to Flextronics. Calgary assets taken over by Flextronics include product integration, testing, repair and logistics operations. About 650 Nortel employees in Calgary will join Flextronics as part of this final step.
Nortel has transferred essentially all of its remaining major manufacturing activities to Flextronics through an outsourcing agreement that was announced in June 2004. Marked by a series of delays, the outsourcing transaction between the two companies was originally slated for completion in the first half of 2005.
In earlier transfers, Flextronics took over Nortel System House operations in Montreal, Canada; Châteaudun, France; and Campinas, Brazil. The provider also assumed optical design operations in Ottawa, Canada, and Monkstown, Northern Ireland, and parts of repair and reverse logistics in North America and Europe. However, Nortel retained its Monkstown manufacturing operations, which were originally part of the outsourcing agreement (Sept. 2005, p. 3).
Flextronics to add some 20,000 employees in Asia
Late last month, Peter Tan, president of Flextronics Asia, told Reuters that Flextronics will hire about 20,000 more people in Asia in the next 12 months.
Canadian Provider Being Sold
Publicly held Moventis Capital of White Rock, British Columbia, Canada, an acquisition and growth management firm, has signed a definitive agreement to acquire PTL Electronics, a profitable EMS company located in Delta, British Columbia, Canada, near Vancouver.
Moventis will purchase PTL for Can$7 million, consisting of Can$3.5 million in cash and Can$3.5 million in convertible debt and equity. For the year ended March 31, 2006, PTL generated revenue of more than Can$10 million and EBITDA of Can$1.5 million. The transaction is subject to financing and customary closing conditions.
PTL specializes in production, assembly and test of complex and high-end electronics. The provider serves OEMs in the telecom, industrial control, medical, computing, multimedia and automotive sectors.
“With limited resources, PTL has already done a great job in achieving growth and profitability. They’re well positioned to grow even further with the capital and operational expertise Moventis can provide,” stated Blake Ponuick, chairman and CEO of Moventis.
Added Ponuick, “With strong ties and plans to expand operations to China in the near term, we believe PTL is strategically positioned to move past their current growth stage and participate in the burgeoning EMS sector internationally. We look forward to working closely with their experienced team to help develop the company both internally and through complementary acquisitions.”
According to PTL’s website, PTL will expand manufacturing and procurement resources into southern China in 2006.
The first acquisition for Moventis, PTL will act as an anchor company within the EMS sector. This deal is in line Moventis’ strategy to acquire small-to-mid-sized companies and build strong portfolios within key growth industries.
Deal done…Publicly held Lyrtech (Quebec City, Canada), a supplier of DSP solutions, has closed its acquisition of Innovator Electronic Assembly, an EMS provider based in Montreal, Canada (April, p. 4-5). Lyrtech also secured private placement financing of Can$6 million and a new banking facility of Can$8.5 million. This private financing obviated the need for a subordinated debenture, previously planned.
Kimball Acquires Automotive PCBA Unit
Under the terms of a new outsourcing agreement, Kimball Electronics Group (Jasper, IN), an MMI Top 50 EMS provider, will produce PCB assemblies for Magna Donnelly, which has sold its PCB assembly operation in Longford, Ireland, to Kimball. The two companies have agreed to enter into a long-term manufacturing relationship to support the needs of Magna Donnelly’s automotive mirror business. Magna Donnelly is part of the Magna International group, a large, diversified automotive supplier.
“Magna Donnelly is a worldwide leader in automotive mirrors, and we are excited to offer them access to our own global footprint of certified automotive manufacturing facilities,” stated Don Charron, president of Kimball Electronics. As of 2005, all of Kimball Electronics’ facilities achieved TS 16949 certification.
This is the second European acquisition for Kimball in the last two months. In April, the provider took over a medical manufacturing operation in Wales from a division of Bayer HealthCare (April, p. 5).
Kimball Electronics Group is a subsidiary of Kimball International.
More new programs…Arima Communications (Taipei Hsien, Taiwan), a large ODM (see p. 2), has changed its handset relationship with NEC, a major customer, from OEM, or contract manufacturing, to joint design or ODM. As a result, NEC will become Arima Communications’ customer for a 2.5G and 3G phone. The ODM plans to expand its R&D staff to “a thousand-member scale” this year….DRS Technologies (Parsippany, NJ), a Top 50 provider, recently booked a $21-million contract to provide EMS, primarily associated with the assembly of cables and electronics supporting the US Army’s Bradley Fighting Vehicles….BAE Systems (Nashua, NH) has awarded LaBarge (St. Louis, MO) long-term contracts to manufacture ruggedized circuit card assemblies used in military applications. The initial order under these contracts is valued at $4.5 million. …EMS provider Electronic Systems, Inc. (Sioux Falls, SD) and AbleNet (Minneapolis, MN), which offers technology and programs for people with disabilities, have signed a multiyear agreement whereby Electronic Systems will supply substantially all of AbleNet’s hardware products.
New facilities…This month, Solectron (Milpitas, CA) launched its FinePitch Technology operation in Wilmington, MA. The FinePitch East facility provides NPI and low-volume, high-mix capabilities in the New England region. Solectron’s FinePitch unit entered the New England market last year through its purchase of a Teradyne PCB assembly operation in North Reading, MA (June 2005, p. 5). FinePitch also maintains an operation in Fremont, CA….Elcoteq (Espoo, Finland) has relocated to new facilities in Manaus, Brazil, and Juarez, Mexico. The new Elcoteq site in Brazil has 5,000 m2 of floor space, compared with the old plant’s 1,500 m2. When fully utilized, the new facility is expected to house up to 800 employees to support communications technology customers that sell products in Brazil or export them to other Latin American countries. At 13,700 m2, the new Juarez facility is smaller that the old plant, which offered 17,000 m2. Elcoteq got started in Juarez through its acquisition of a Thomson set-top box manufacturing operation at the end of 2004. In addition to producing set-top boxes, the Juarez operation manufactures communications network equipment and provides test development services. Elcoteq employs roughly 1,600 people in Juarez….Also in Brazil, handset ODM Arima Communications is working with Flextronics on establishing a virtual factory. Arima Communications is leasing factory buildings and equipment from Flextronics and using Arima personnel to control the yield rate, production scheduling and so on. The ODM will consider establishing its own factory there in the future, if monthly output exceeds a half million sets….During Q1, Jurong Technologies (Singapore), a Top 50 provider, completed a new facility in Suzhou, China, which is expected to start operations in Q2. Also in Q1, the company expanded further its capacities in Malaysia, China and Brazil to meet growing demand….According to DigiTimes.com, ODM Inventec (Taipei, Taiwan) plans to set up a wholly owned subsidiary in Mexico for the supply of servers and related products to the US market.
Shifting from North to South China…PEMSTAR (Rochester, MN), a US-traded EMS provider in the Top 50, is in the process of establishing a South China facility in Shenzhen. The company is also evaluating strategic alternatives and partnerships for its North China site in Tianjin, which is a significant contributor to PEMSTAR’s revenue. The Tianjin site is associated with PEMSTAR’s turnkey cell phone business, which does not mesh with the company’s effort to reposition itself in market segments that are non-consumer based. The provider is targeting segments such as industrial, medical and instrumentation. “We see the opportunity for that type of shift more in the Southern China area than we do in the Northern China area,” said Roy Bauer, PEMSTAR’s president and COO, during a May conference call with analysts. He noted that the company’s cell phone business was marginally profitable in its fiscal 2006, which ended in March.
Alliances…Integrated Microelectronics Inc. (Laguna, Philippines), a Top 50 EMS provider, has formed a strategic alliance with BuS Elektronik (Riesa, Germany), also an EMS company. Under an alliance agreement, the two companies will jointly seek subcontracting projects from European OEMs, and BuS Elektronik’s facility will serve as IMI’s fast prototyping and NPI center in Europe. The idea is to transfer production to IMI operations in Asia when volumes increase. IMI’s facilities in China, the Philippines and Singapore can also service BuS customers who want to develop, produce or sell their products in Asia. Founded in 1991, BuS Elektronik is a medium-sized EMS provider from Saxony, whose customer base mainly consists of automotive and industrial electronics OEMs….Jurong Technologies has taken its existing alliance with China Precision Technology (CPT) a step further. Last month, Jurong took a 25.23% stake in the Chinese manufacturer of metal and plastic components, which became an associated company of Jurong. Under the alliance made last year, each will act as the preferred subcontractor to the other and its respective customer base (Nov. 2005, p. 6). In addition, Jurong and CPT will jointly carry out ODM development of plasma display panel and LCD products and telecom product accessories. CPT recently went public on the Singapore Exchange….Arrow OEM Computing Solutions, a unit within distributor Arrow Electronics, has formed a partnership with DecisionOne to provide an end-to-end kiosk solution to kiosk application developers and manufacturers. While the Arrow OCS solution supports kiosk customers from concept design through global order fulfillment, DecisionOne will provide post-manufacturing support services.
Jabil Review Finds No Backdating
Responding to a March 18 article in the Wall Street Journal, Jabil Circuit (St. Petersburg, FL) has conducted an internal investigation of its stock option grant practices and found no issues of backdating or improper actions. The article called into question option practices at six companies including Jabil for the period of 1995 through 2002.
A preliminary review by a committee of Jabil’s board of directors and a separate management review determined Jabil’s management and its board have not backdated options for any of its officers or directors.
The Securities and Exchange Commission informed Jabil that it would ask Jabil for certain documents as part of an informal inquiry into option granting.
Cowen analysis raises questions about Sanmina-SCI’s timing
Analysts at Cowen and Company examined stock option grants at four other EMS companies and reported that “there could be issues with Sanmina-SCI.” In a note published on May 2, Cowen analysts wrote, “From October 1998 to October 2002, Sanmina-SCI had very fortunate timing with picking their options exercise price.” The Cowen analysis found that in three years 1998, 1999 and 2001 the grant price corresponded to the spot-on low during the December quarter, while in 2000 the price was one day off from the low. In addition, Cowen analysts discovered that in four cases stock performance in the 20 days after a grant ranked in the top five periods out of 252 trading periods in a year.
“We’re confident that we haven’t done anything wrong,” said Carmine Renzulli, executive VP for legal and human resources at Sanmina-SCI.
He told MMI that he is conducting a review to confirm his belief that the company has followed the rules. Renzulli said Sanmina-SCI will have more to say when the review is completed.
Tier-one dividend…Jabil put its tier-one competition on notice when earlier this month the company declared its first quarterly dividend, which amounted to $0.07 per share.