COMMENTARY--Ramblings from J.P. Morgan H&Q's annual technology conference in San Francisco:
Inventory? Not my problem. Or so says Jabil Circuit (NYSE: JBL) Chief Financial Officer Chris Lewis.
One of the commonly cited reasons for the telecom equipment slowdown was a product glut, because carriers overbought in the first half of 2000. It's taking several quarters to get rid of inventory excess, and with contract manufacturers now building many of the systems sold by Cisco Systems (Nasdaq: CSCO), Nortel Networks (NYSE: NT) and other communications hardware companies, many observers are wondering who will get stuck with the excess.
Jabil expects its inventory problems to mostly go away in the current quarter, but Lewis says most of the extra inventory didn't end up on his company's books anyway. Most parts either go back to the telecom equipment company, or are stored by the contract manufacturer and recorded as cash or receivables until they're actually used.
Companies like Cisco won't force the Jabils of the world to eat inventory because that would cost the communications hardware vendors more in the long run, Lewis believes. "Nobody does that, because there's not pricing in the model," Lewis said. "For every dollar we make, Cisco makes $30 to $50."
He has a point.
Jabil's operating margin in the latest quarter reported was less than 5 percent. Given that the whole point of using contract manufacturers is to save money, it makes little sense to drive them out of the business by pushing huge inventory write-offs onto them.
Of course, that whole debate only applies to original equipment companies that stink at manufacturing. Your typical communications hardware vendor can't turn inventory nearly as fast as a contract manufacturer with cheap overseas operations. Then there's Nokia (NYSE: NOK).
Unlike rival Ericsson (Nasdaq: ERICY), the Finnish wireless equipment giant says it doesn't need subcontractors because it can match anyone in manufacturing efficiency. And Jabil's Lewis agrees.
"We've criticized a bunch of OEMs in secret, but Nokia's (facilities) are just awesome plants. Those would be great plants to buy."
Or just grab talent from contract manufacturers. Robert McIntyre, chief technical officer for Scientific-Atlanta (NYSE: SFA), couldn't stop smiling during his talk, and who can blame him? Scientific-Atlanta is surging in the TV set-top box market, having boosted its market share to roughly 40 percent from the low 20s just a few years ago.
Cable companies love those new digital boxes because they add revenue, as much as $20 per customer on top of the regular monthly bill, according to McIntyre. But Scientific-Atlanta also has to be able to make these boxes for less than $300 each, and it does that all itself. Some set-top box makers farm out their manufacturing, but Scientific-Atlanta simply hired several managers from contract manufacturers to run its own lines, McIntyre said.
Scientific-Atlanta's high-end box, the Explorer 8000, should hit volume production late this year, he said. Besides the ability to handle things like program guides, high-speed Web surfing and e-mail, video-on-demand and online shopping--ordering a pizza was one of McIntyre's favorite examples--the 8000 will include a 40-gigabyte hard drive. Scientific-Atlanta hasn't chosen a hard drive brand yet, but whoever wins that contract will be dancing in the streets; the overall market for set-top boxes is expected to hit 100 million by 2005.
TiVo (Nasdaq: TIVO), on the other hand, better figure out a way to turn itself into something broader, because those hard drives in set-top boxes are for digital video recording. TV time-shifters won't be premium products anymore, but cable commodities with an easy interface.
"People who have TiVo love it, but one of the reasons why TiVo has had difficulty is because it's hard to understand," McIntyre noted. "We can explain it."
Would you solicit advice from these executives at an investor show? Former or soon-to-be-former CEOs of publicly traded companies at yesterday's luncheon panel on "Silicon Valley meets Washington, D.C." were Eric Benhamou of 3Com (Nasdaq: COMS), Eric Schmidt of Novell (Nasdaq: NOVL) and Kim Polese of Marimba (Nasdaq: MRBA). Perhaps presiding over the loss of billions in shareholder value makes someone uniquely qualified to deal with politicians.
3Com's stock price fell 88 percent over the last five years of Benhamou's CEO tenure. Novell's shares have dipped more than 80 percent since the April 1997 appointment of Schmidt, who will step down this year when his company's merger with Cambridge Technology Partners is completed. Polese's run at the head of Marimba (Nasdaq: MRBA) ended with the stock down 67 percent from its first-day closing price. 22GO>