Building on a mere 3% expansion in 2003, total EMS revenue is forecast to rise 15% in 2004, 16% in 2005, and 11% on a CAGR basis over the six years ending 2007. Original device manufacturers (ODMs) will grow at an even faster 25% CAGR over the same period, according to market research firm iSuppli Corp., El Segundo, Calif.

Most of the growth will occur at the top-tier companies, especially at vertically integrated entities like Celestica, Flextronics, and Solectron, the same group that was heavily panned the past three years for its bloated operating structures, according to analysts.

"In a downturn, a vertical structure is a burden, but in a market recovery it is a major advantage," said J. Keith Dunne, an analyst at RBC Capital Markets in San Francisco.

"The best opportunities lie with well-managed, vertically integrated EMS providers with emerging ODM models," said David MacGregor, an analyst with Cleveland-based Longbow Research LLC, in a report. The new assessment is hardly a ringing endorsement of vertical EMS structures. In fact, analysts contend the improving fortunes of companies like Celestica and Flextronics highlight the fluctuations embedded in their vertical operating systems, which tend to be tied closely to the ebb and flow of the cyclical electronics market.

While Celestica, Flextronics, and Solectron are gearing for renewed growth, a few EMS providers that have grown right through the downturn are wondering what all the fuss is about. Benchmark, Foxconn, and Jabil Circuit were relatively unscathed in 2001 and 2002 and will maintain their steady growth, according to analysts.

"The company that performed the best during the downturn was Benchmark. That's unequivocal, because Benchmark grew while others were cut in half," Dunne said. "Benchmark and Jabil had fewer acquisitions and they stayed focused. These two don't need to recover because they never fell."

Both Benchmark Elecronics Inc. and Jabil Circuit Inc. limited their operations to specific market segments, using what Dunne described as a virtual operating structure to meet OEM demand without piling up overhead that could easily be rendered a burden in a downturn.

"Historically, Jabil has been less aggressive than its peers in pursuing acquisitions and OEM asset purchases, which has proved the best strategy in the aftermath of the tech bubble," said Steven Fox, an analyst with Merrill Lynch & Co. Inc., New York, in a report. "Jabil has remained true to its horizontal business strategy, which focuses on traditional EMS services such as PCB assembly, full system assembly, design, and support services."

Jabil and Benchmark are expected to maintain their strong performance over the next several years, although they may lose some market share as the top three EMS providers ramp production. In addition to the cost-cutting conducted during the last recession, the market leaders are no longer averse to competing for the smallest contracts in all market segments, analysts said.

"In response to the infrastructure downturn, a number of top-tier companies began to target a more diverse customer base, including the lower-volume, higher-mix, highly regulated Class II and Class III medical electronics segment," said Jim Savage, an analyst at New York-based Wells Fargo Securities LLC, in a report.

Savage said that the market recovery should make it possible for even smaller EMS companies like Plexus Corp. to retain share in niche markets despite a strong challenge from the top tier. For now, Singapore's Flextronics International Ltd., the world's No. 1 EMS company, Celestica Inc., and Solectron Corp. can use the good news. All were battered in the market downturn as demand for their services fell sharply in the PC and telecom markets.

Analysts expect Flextronics' revenue to improve slightly to $13.7 billion in its 2004 fiscal year ending March 31, from $13.4 billion in 2003, and then rise to $14.9 billion in fiscal 2005. Celestica, which experienced a severe sales decline the last couple of years, is expected to report revenue of $6.6 billion for 2003, down from $8.3 billion in 2002 and $10 billion in 2001. However, its revenue is forecast to rise to $7.2 billion in 2004. At Solectron, revenue is expected to increase to $11.9 billion in fiscal 2004 ending August, and $13.3 billion in fiscal 2005 from $11 billion in fiscal 2003.

The higher revenue these companies are expected to report will come largely from their ability to deliver more comprehensive solutions to OEMs, many of which would rather concentrate manufacturing with a single provider to lower costs.

As volume production increases over the next few quarters, capacity utilization will also improve, raising margins at the vertically integrated companies, according to analysts.

However, although now poised to leverage their vertical structures to seize additional market share, the trauma caused to the top-tier companies' balance sheets by their cost-cutting programs has yet to dissipate.

"EMS companies have done a good job of cleaning up their balance sheets and generating cash flow over the past year," said Chris Whitmore, an analyst with Deutsche Bank Securities Inc., San Francisco. "[But] three years of restructuring charges and significantly improved working capital velocity has not resulted in improved returns on invested capital in the EMS industry."

By: DocMemory
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