While Cisco Systems Inc's slowing business has hurt its suppliers, the latest twist in Cisco's fortunes may be a boon for contract manufacturers Jabil Circuit Inc and Solectron Corp, says Roger Norberg of JP Morgan Securities Inc.
Cisco plans to write off US$2.5 billion of parts and unfinished goods, clearing the decks for new, more profitable products. That means Jabil and Solectron, which assemble circuit boards and other goods for Cisco, aren't on the hook for the unused inventory, Norberg said.
"Cisco is set to take responsibility for ownership and liquidation" and that "should be a substantial relief," Norberg wrote in a report.
Jabil and Solectron shares have fallen as much as 60 percent from their highs of last year as investors worried the companies would be burdened by excess components that have accumulated because of slowing sales.
Cisco's move suggests other customers may also take responsibility for the unused inventory, even as new products make it obsolete.
"When the bottom dropped out of demand in the fourth quarter [of 2000] investors became nervous about potential [contract manufacturer] liabilities for unused and obsolete parts," Norberg wrote in a note to clients.
Though Cisco's move, announced yesterday, "does not eliminate every excess component in the channel, it should remove a large amount." Significant money is involved.
Solectron, for example, "may be carrying in excess of US$500 million in parts inventory that is earmarked for Cisco," Norberg wrote.
Cisco is Solectron's second biggest customer and Jabil Circuit's biggest.
Norberg is the first to signal it might be time to buy Solectron, Jabil or other companies that provide manufacturing services in anticipation of a turnaround for their customers.
Other analysts also spoke favorably about the effect of Cisco's inventory writedown. Only Norberg raised his ratings on the shares. He boosted Solectron and Jabil to "buy" from "long-term buy," which is one notch lower at JP Morgan.
Since January, Wall Street has been cutting ratings on the contract manufacturers. Seven firms downgraded Solectron after the Milpitas, California, company said on March 19 that profit would miss forecasts due to slowing demand from customers, including Cisco and International Business Machines Corp.
Jabil said the next day that its earnings also would be disappointing.
Norberg is right to be trumpeting the value of Cisco's move for the so-called contract manufacturers, said Jerry Castellini, president of CastleArk Management LLC in Chicago, which manages US$1.5 billion.
The decision "is the big-boy way to approach the problem" of excess inventory, Castellini said. "They are saying, `long-term, if we don't clean up, it's going to come back to bite us.'"
Castellini said he sold his shares of Jabil and Solectron in the third quarter of 2000, avoiding their declines. He is now deciding whether the time is right to return to the industry.
"I've got price charts of nine of [the companies] sitting on my floor right now," he said.
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