Electronics Production | February 05, 2010

2010 ushers in a new decade in EMS

What a decade the “00’s” have been: boom and bust followed by a mild boom and a giant bust! The decade was ushered in by a “tech wreck” led recession and ushered out by the greatest global recession in a generation. But through it all consumers kept consuming gadgets, businesses kept investing in IT, capital equipment and communications technology, and the EMS engine continued to crank out the products the world uses.
By: Ron Keith, Chief Executive Officer at Riverwood Solutions

Despite two different periods of significant revenue contraction, the global EMS industry closed the decade having posted impressive growth since the turn of the millennium. Even with the mild contraction of 2008 and the train wreck of 2009, the global EMS industry grew by approximately 125% in the decade (according to Riverwood Solutions’ Global EMS Index.)

So what will the New Year, and the new decade hold for the EMS industry? Will growth reaccelerate or is the maturation of the industry destined to bring slower growth? What strategies will come to the fore and what companies will make new headlines with acquisitions or bankruptcies?

Although I have no specific knowledge of any of the changes or events I am about to predict, my views are modestly informed by a broad exposure to the issues, challenges and trends facing the EMS industry and its OEM customers. The predictions below are intended to be thought provoking around key issues, and not actual psychic visions.

Top 10 Predictions for 2010 that Will Impact the EMS Industry

1)Cisco Systems sues a number of ODMs and a few of their OEM customers over patent infringement and intellectual property rights.

The increased use of mostly Asian ODMs to design increasingly complex systems for enterprise data and storage is inevitably pushing that industry towards a show-down with some of the major western IT vendors. ODM and CDM services contracts in general continue to be a bit light on IP infringement validation and indemnification as many of these companies employ only “reasonable efforts” or less to verify potential sources of patent infringement. As smaller OEMs outsource more of their design efforts and become decoupled from most of the design process (except for product architecture), the ODM design teams take on an increasingly important role in fundamental design decisions that can have significant IP consequences. Many ODM and CDM companies simply do not have the well-defined and highly rigorous processes in place to identify potential sources of IP infringement in the design process, while certain others tend to turn a somewhat blind eye to all but the most egregious infringements.

2)Celestica and Sanmina-SCI merge and rebrand the company under a new name.

As Foxconn and Flextronics have emerged as the new super-tier of the EMS industry, some companies previously considered tier-one are struggling to find their place. Too small to be big and too big to be small, these companies may see a marriage as a good strategic solution to their market positioning. Celestica has long been a leader in the assembly of highly complex systems for telecom, while Sanmina-SCI’s highly profitable printed circuit board operations have long been a gold standard for large form factor, high density boards and backplanes. The combination of these two companies would position them on par with Jabil in terms of revenue and should provide some cost synergies in S, G & A, procurement, and design.

3) The Euro falls precipitously against the U.S. dollar, breaking below $1.25.

The continued fiscal difficulties in the southern Euro zone exert significant pressure on the decade old currency basket creating unrealistic levels of uncertainty about the currency’s future. New financial regulations in the U.S. and U.K. that have been designed to curb investment speculation in currencies and other instruments backfires, sending the Euro down hard in volatile trading as institutions are faced with fewer financial instruments that allow them to hedge Foreign Exchange risk. I predict that the Euro zone dips back into recessionary territory in the second half of the year suppressing demand for electronic products and EMS services.

4) Goldman Sachs, the world’s premiere Investment Banking house, is taken private in the largest private equity deal in history.

In a deal valued in excess of $100B, a syndicate of U.S., European and Asian private equity firms take the 140 year old Wall Street icon private to avoid increasing financial regulations in the U.S. and U.K. The landmark transaction, surprisingly accomplished with an extremely modest 5:1 leverage, sends global equities soaring as investors place their bets on the next big firm to be taken private. Shares of EMS companies temporarily skyrocket as investors reexamine the ability of these companies to produce significant cash flow streams even in the face of very modest GAAP earnings.

5) Divestitures, Mergers, and Acquisitions in the EMS industry return to normal levels and begin to reshape the competitive landscape.

Like most industries, M&A activity is generally a very strong contrarian indicator of both the health of an industry and the industry’s short- to mid-term prospects. Acquisition activity tends to peak when valuations and growth rates are high, and activity tends to reach a nadir when valuations are cheap and current growth rates are low. The unprecedented dearth of deals over the past five quarters most likely signals a short term bottom in industry growth rates was reached in 2009 and that 2010 will see a rebound in acquisition activity.

Throughout the last decade, EMS industry deals averaged just over one deal per week or about 55 deals per year. Even when adjusting for the boom year of 2000 and the bust year of 2009, this average deal level remained intact, suggesting a strong tendency for M&A activity to revert to the mean. This bodes well for an increase in industry M&A in 2010, which will be driven primarily by consolidation transactions and vertical (mostly design) transactions in the third and fourth tier of the industry. As the global economy retreats from the brink and balance sheets and equity prices recover, EMS executives who have had strategic plans on hold will move to increase their scale or close perceived gaps in their service offering. Acquisition activity should more than double from 2009 levels, with Europe seeing more total transactions than any other geography. Since the EMS industry on the continent remains more fragmented than in other regions, we should expect to see more EMS industry consolidation type transactions.

Stay tuned for the rest of my 2010 predictions in a forthcoming article on evertiq.
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