EMS providers panting for the kind of megadeals that drove the sector's growth in the 1990s are predicting that Royal Philips Electronics' sale of its contract manufacturing unit to Jabil Circuit Inc. will help trigger a wave of outsourcing by so-far hesitant consumer electronics makers.
The four-year, $4 billion manufacturing deal between Jabil and Philips announced last week indicates the EMS industry may be on to something. After years of trailing the communication and PC sectors in outsourcing, consumer electronics OEMs are being drawn by the need to cut costs in a depressed and highly price-sensitive market, according to industry executives.
"Philips being one of the top three consumer electronics companies in the world, this transaction will provide an impetus to other companies to outsource," said Tim Main, Jabil's president and chief executive, during a presentation to analysts last week. "We think this transaction is very indicative of what is happening in the consumer electronics segment as companies really start to focus on those activities that provide the highest return."
Jabil said it will pay $231 million to acquire Philips Contract Manufacturing Services (PCMS). The companies signed an agreement guaranteeing about $4 billion in sales to Jabil over a four-year period.
The St. Petersburg, Fla., EMS company is taking over 5,000 employees and nine facilities on three continents and will provide design, engineering, and other production services for Philips' consumer electronics division.
While clearly a boon for Jabil, which triumphed over several other contenders, the sale of PCMS is a tacit admission by Philips, based in Amsterdam, Netherlands, that its 1999 foray into the EMS business was a blunder. The company had set up PCMS as a stand-alone company to service its consumer electronics division and outside contracts.
Although PCMS quickly became the world's No. 10 EMS provider with 2001 sales of approximately $1.3 billion, according to Scott Robertson, an analyst at Investec Inc., Conshohocken, Pa., it did so mainly as a result of Philips' patronage. PCMS produced 70% of Philips' consumer electronics printed-circuit-board assemblies and was only able to win a few other small contracts.
Analysts said Philips' Japanese rivals are walking down the same lonely road. A few of these companies have in recent times created similar in-house EMS units in the hope of benefiting from the procurement and production leverage available to contract manufacturers while retaining control of the business.
"I don't think setting up in-house EMS units is the way to go," Investec's Robertson said. "The Japanese companies are reluctant to give up their in-house EMS, but we're already starting to see some cracks."
With only 9% of an estimated $100 billion consumer electronics market currently outsourced, Jabil's Main sees additional manufacturing opportunities for EMS providers opening up at the leading consumer electronics companies.
"I think the growth rate of the EMS providers in the consumer electronics sector will be about 40% per year as the penetration rate increases over the next five years," he said.
The agreement with Philips is certainly adding a bounce to Jabil's revenue and profit forecasts. Analysts said the deal will increase Jabil's fiscal revenue by about 25%, and over time will boost its earnings per share by 3 to 4 cents.
In addition, the capacity utilization rate at the nine manufacturing plants that Jabil is taking over range from 75% to 80%, well above the industry average of 55%, according to analysts. Eighty percent of the plants are also in low-cost locations, and even the ones in high-cost centers are in European countries where many customers prefer to have their EMS providers situate design and new-product-introduction operations.
With the deal, Jabil also gets a chance to prove it can handle manufacturing services for other Philips units, analysts said.
"The [transaction] provides opportunity for additional outsourcing to the industrial [lighting], medical, and appliance sectors of Philips," said John McManus, an analyst at Needham & Co. Inc., New York, in a report.
Not all analysts were as thrilled about the Philips deal, however. This is Jabil's sixth transaction in as many months, raising the possibility that the company, which had previously pursued a policy of growth through internal expansion, could run into problems integrating the businesses.
Also, the consumer electronics market is known for its slow growth and analysts believe its expansion could slow even further if the economy fails to rebound soon.
"While the strategic benefits from acquiring PCMS are numerous, we question Jabil's timing for diversifying into the consumer electronics end market," said Chris Whitmore, an analyst at Deutsche Bank Securities Inc., San Francisco.
"Despite the accretive nature of the deal, the Philips acquisition will clearly result in a lower-margin profile for Jabil," Whitmore said.