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THE DAY AHEAD: Solectron sees torrid growth ahead

Tech Industry

Solectron Corp. (NYSE: SLR) isn't the most glamorous of tech companies, but it sure is one of the better performing ones. And investors would be remiss if they didn't put it on their radar screens.

Don't be fooled if Solectron falls Tuesday because it is spending $2 billion for Smart Modular Technologies (Nasdaq: SMOD chart). Anytime there's an acquisition, the buying company usually falls even if the deal makes long-term sense. More on the Smart Modular buy later (See full statement.)

Bellwether in the making?

Solectron, a contract equipment manufacturer, will never be mentioned in the same breath as Dell Computer Corp. (Nasdaq: DELL), Cisco Systems (Nasdaq: CSCO), Intel Corp. (Nasdaq: INTC) and Microsoft Corp. (Nasdaq: MSFT), but maybe it should.



Solectron: Tech powerhouse?



"Solectron is not a tech bellwether," said James Savage, an analyst with Thomas Weisel Partners. "But institutions are increasingly seeing Solectron as a way of playing the tech sector without the risk." Thomas Weisel was an underwriter for Solectron's latest equity offering, but Savage is hardly alone. Seventeen analysts rate Solectron at least a "buy."

Quarter after quarter, Solectron delivers solid results and whopping growth for a company its size. On a conference call, Solectron officials upped the fiscal 2000 revenue target to $13 billion, up 55 percent from 1999, and urged analysts to boost earnings estimates to $1.60 a share from $1.51 a share.

Can't ask for more than that.

Solectron's fiscal fourth quarter was the usual solid performance. Solectron topped estimates with fourth quarter earnings of $88.8 million, or 33 cents a share, on revenue of $2.4 billion. For perspective, fourth quarter sales were up 41.5 percent from a year ago and earnings jumped 58.9 percent. For the year, revenue was up 58.7 percent to $8.4 billion and earnings were up 47.8 percent to $293.9 million from 1998. (See full statement.)

Outsourcing gold

So what makes Solectron so special? It's in the middle of one of the largest trends in the technology world -- outsourcing. Solectron makes equipment for Cisco, one of Solectron's largest customers. Solectron makes servers for IBM (NYSE: IBM) and Sun Microsystems (Nasdaq: SUNW). Solectron makes gear for telecommunications companies such as Ericsson (Nasdaq: ERICY) and equipment vendors such as Nortel Networks (NYSE: NT).

Analysts expect that Solectron will soon be making a lot of telecommunications equipment for players such as Lucent Technologies (NYSE: LU) and Alcatel (NYSE: ALA).

It's no wonder why the institutional guys are becoming big fans. Lucent and Cisco can beat up each other and IBM and Sun can duke it out, but they'll still come to Solectron to outsource manufacturing. "They have a broad customer base and aren't vulnerable to anyone's particular shortfall," said Savage.

Smart Modular a smart buy

And now it's time for that Smart Modular acquisition. The purchase gives Solectron more manufacturing capacity for its growing business and forms the base of a services unit. Smart Modular, which makes memory modules and cards, embedded computers and other devices, will give Solectron a "technology solutions business unit." In plain English, it's one thing tech companies can farm out to Solectron. Product cycles are getting shorter by the day and companies just don't have time to build big manufacturing plants.

In addition, Solectron gets a company that was growing at a rapid clip because of the same outsourcing trend that has fueled Solectron.

The Smart Modular acquisition is expected to add about 9 cents a share to fiscal 2000 earnings before charges and $1.1 billion in revenue.

There are risks of course. Solectron is growing fast and execution is a risk. And now Solectron is getting 1,900 Smart Modular employees and 290,000 square feet in manufacturing space. It also is facing competition from the likes of Jabil Circuit (NYSE: JBL) and a host of others, but Solectron's balance sheet is strong and it built up a nice war chest with its latest equity offering.

Since Solectron's margins are thin, any slowdown or disruption in the supply line for components and other parts could cause problems. But given Solectron's track record, who is going to bet against them?

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