MarketWatch Commentary

The good news: Three years to full rebound.  2010-2013, is the general consensus forecast for the EMS industry globally to fully recover to pre-recession levels.  Conservative growth is forecasted in the 5% range and the majority of analysts (including SIA, KPMG, iSuppli, and Gartner) and economists forecast more bullish numbers in the low double digit percents, annually for those next three years (as reported in Manufacturing Market Insider  (MMI) (Vol. 20:1, January 2010, and Vol. 19:11, November 2009) and citing forecasts from InForum, SIA, IDC, and Electronic Trend Publication). 

EMS companies have been faring well, relatively speaking, and the strategic moves to diversify into new markets with important core capability links has analysts and market researchers generally more bullish than conservative. 

What is particularly interesting, as we continue to watch the ongoing EMS-ODM turf war (cf. MarketWatch Quarterly Vol. 1:1, "EMS/ODM a Mixed Market;" and Vol. 2:2, "Co-Evolution and Organic Growth"), is the varied strategies EMS companies are embracing.  As well presented in the latest MMI (Vol. 20:1, pp. 1-4) report, some EMS companies are following a new, retail path (e.g., Hon Hai's retail outlets); some are expanding to sister industries (e.g., Jabil's venture into solar panels and medical disposables); some are supporting new supply chains for the still fragmented clean/smart technologies (cf. the latest MarketWatch Quarterly Vol. 3:4, now available to subscribers and next week to the public); and some are engaging in more traditional M&A deals to expand their market reach and capabilities (e.g., Celestica's acquisition of Invec Solutions, as reported in MMI Vol. 20:1, pp. 2, 7).

Among the other trends forecasted by market analysts, we should see a resumption of more normal consolidation numbers for small- to mid-sized companies, renewed momentum for regionalization/localization (cf. MarketWatch Quarterly Vol. 2:3, "An Expanding European Microcosm" for more discussions on localization), and continued distinctions between EMS and ODM businesses but with increased "credibility to a hybrid strategy" (MMI Vol. 20:1, p.4).

The next one to three years hold promise for the EMS sector, and based on early analysts' reports for 2010, the new market opportunities may provide important growth for EMS in directions beyond the past 'turf wars' with ODMs.

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Of course we all know the important news out of Japan for 2Q09, the first GDP uptick in five quarters.  That's tremendous and portends serious positives for the APAC region as well as global economic recovery momentum.  But there's more to the news out of Japan: as part of the government's stimulus efforts, increases in public spending and use of public funds to bolster those private companies worst effected by the global recession have made cash available.  With an eye to increased consumer spending in Japan as well as improved export numbers, up 6.5% for 2Q09 QoQ (Credit Suisse Japan Macro Flash 17 Aug 2009), the time to invest in local companies is well aligned and is inline to support the positive trend for recovery.

At the center of upstream semiconductor news is Japan with the now-back-on-again merger of Renesas and NEC Electronic into "the world's third-largest semiconductor maker after Intel Corp [...] and Samsung Electronics Co [...]," according to Reuters recent updates.  One of the hurdles though is the amount of debt refinancing necessary and the issue of government support to the tune of roughly 200 billion yen.  This on top of Japan's recent pledge to help Elpida Memory Inc, also severely hurt by the global economic crisis. 

While MarketWatch Commentary tends to not focus on individual companies, the merger, now seen as likely to be completed in early 2010, signals important changes to the supply chain and the competitive landscape, particularly for MCU production.  As for the impact on the industry, the increase in competition is important and will be interesting to watch, particularly as chip makers were hit hard by the global crisis.  There will be an uphill period for the new merged company, likely to fall under Renesas's name, as a result of redundancies in product, design, and then the restructuring post-merger (see HERE for a pro-con summary from EETimes).

While the impact on the global supply chain is likely to be delayed until the restructuring is completed, the opportunities for Japan to restake it's claim to semiconductor manufacturing are ripe.  Along with other trends diversifying into solar PV and the help to Elpida, Japan will be a country to watch as a new, global economy awakens.

Watch for a review of the new geo-economic landscape for the semi industry in the upcoming  MarketWatch Quarterly.

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With the latest Manufacturing Market Insider (MMI) out this week, new numbers reviewing the widespread effects of the global recession on the EMS and ODM sectors in semiconductor industry are also available.  Turns out that the lull in spending was not only the purview of the enterprise or general consumer, but extended to the corporate merger and acquisition (M&A) market as well.

MMI's numbers show that M&A, inclusive of consolidations, were down by roughly 80% YoY!  Yes, that is indeed a historic number.  To simplify, general analysts' consensus is that during economic downturns consolidations tend to rise as a result of cash-strapped corporations looking to increase margins, move capabilities back in-house, and/or simply find alternative ways to stave off insolvency or to make a market move for future expansion and market share increases by acquiring capabilities during a fire-sale.  This just didn't happen, despite what we all thought!

Interestingly, cash savings and murky outlooks seem to have been so much at the fore that even the opportunity to buy while the buying was good proved to be too risky for most.  Moreover, the historic downturn in 1H09 breaks a long-standing EMS/ODM market trend of regular M&A activity in order to increase or expand capabilities. 

As MMI notes, the lack of M&A activity in light of the EMS/ODM trend "[...] indicates that in the business climate of the first half some providers either elected to put off acquiring a new capability or decided to develop it in-house instead." (MMI, Vol.19 No.7, p. 2) 

So, what was up?  Joint ventures (JV).  Why?  Well, JVs tend to cost a lot less but come with limited risk exposure for a comparable gain in access to the desired assets or market (ibid., pp. 2-3).  Of note: MMI does not include EMS divestitures that are not retained in the EMS sector which could skew the data (ibid., p.3).

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While the market indicators are pointing towards the bottoming being reached and recovery on the horizon, the news of companies facing tough times is still par for the course.  According to last week's report by SEMI, the April Book-to-Bill ratio is up to 0.65, holding the nice upward trajectory since January's historic low of 0.47.  However, looking at the numbers, while the three-month moving average (3 MMA) for worldwide semiconductor bookings is up slightly to US $253 million, 3 MMA billings is significantly down by 11% month-over-month to US $389.9 million.

What does this mean?  As we've discussed here, as long as bookings (and billings) numbers remain low, we do not have the foundation for a healthy supply chain, to echo Stanley T. Myers, president and CEO of SEMI. 

The result?  Yes, right back where we started: unhealthy supply chains tend to mean tightening supply chains.  The most recent proof of this cause-effect is Sony's announcement last week of halving their supply chain by 2011 in order "to save at least 500 billion yen ($5.28 billion) in purchasing costs this fiscal year," according to The Wall Street Journal.  Sony's website doesn't provide any details, other than what we knew in February about the new Manufacturing/Logistics/Procurement team.   

In the face of declining revenues, many large OEMs have been rethinking their supply chain strategies to trim costs, including the practices of leaner chains and outsourcing.  We are now also seeing 'insourcing' back in vogue.  Along with these OEM supply chain strategies have come the consolidations we've seen and tracked by monitoring a set of indicators for quite a while now here and here, especially.

The fallout for the semiconductor supply chain?  As OEMs like Sony, Hitachi and Toshiba continue to follow tight supply chain strategies, more mid- to small-sized companies will disappear due to insolvency or consolidation and the sourcing of products will, therefore, also tighten significantly.

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As explored in MarketWatch Quarterly last issue and this issue, inventory has truly been upgraded as a leading variable in business strategies as well as an indicator necessary for forecasting and monitoring the health of the entire electronics industry.

iSuppli, in a briefing that just concluded, offers that while significant efforts and rapid response to reign in inventory has been helpful thus far, these efforts are unlikely to be enough to stave off greater problems.  Why?  Well, because while days of inventory (DOI) have been holding at reasonable levels, there are still revenue problems due to plummeting ASPs, extremely demand sparse economies for end products, and supply chain reverberations as distributors at one end and fabs at the other end work to control inventory.  Meanwhile, additional rounds of consolidations and insolvencies are likely ahead for the remainder of 2009.

According to iSuppli analysts this morning, semiconductor DOI is expected to reach 100 days (significantly higher than industry averages of 80 days).  Furthermore, distributors are pushing inventory back to manufacturers which may jeopardize relationships, noted iSuppli analysts, offering that distributors are playing a more important role in the supply chain.

A solution?  According to iSuppli analysts, it is critical that new products are launched which are redesigned to heed the "lower price points" in today's demand sparse economies while taking into consideration the falling ASPs.

Strongest warnings by iSuppli?  In my opinion, the concern over the DOI problems to come, the continued decrease in revenue in conjunction with DOI issues, and the necessity of avoiding the price reduction path which is a slippery slope.

There will be more to come on this topic, certainly.  For more background on the increased role of inventory and utilization levels in the electronics industry as well as supply chain fall out, I recommend reading this and this in the present issue of MarketWatch Quarterly for a deeper understanding of these new variables and stressors on our industry. 

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