By Chris Rugaber (TMF RFK)
June 13, 2000

Trading at $64 7/8 as of June 9, 2000

If your Dad is like mine, he likes gadgets, especially electronic ones. As a result, he probably has the latest cell phone, the latest personal digital assistant (PDA), and the latest computer. Therefore, for Father's Day, why not buy him stock in one of the companies that makes those things? And no, I'm not talking about Motorola (NYSE: MOT), Nokia (NYSE: NOK), or Palm (Nasdaq: PALM).

Instead, I'm talking about Flextronics (Nasdaq: FLEX), one of the leading contract electronic manufacturers (CEMs). Also known as electronic manufacturing services (EMS), these businesses are quietly raking in plenty of money by making many of the electronic appliances we use today. The Fool has written intermittently about CEMs for years, and both our Industry Focus 1998 and 1999 research reports include sections on CEMs. Flextronics, and the industry as a whole, looks as promising now as ever. Other top-tier CEMs worthy of consideration include Solectron (NYSE: SLR), Jabil Circuit (NYSE: JBL), SCI Systems (NYSE: SCI), and Celestica (NYSE: CLS).

More and more name-brand companies, such as Motorola, Nokia, Compaq (NYSE: CPQ), and many others, are subcontracting the actual manufacturing of their products to companies like Flextronics. By doing so, they save on manufacturing costs and can focus on design and other value-added services. A global CEM (like Flextronics, which has facilities in 14 countries on four continents) can also offer inventory management and other services, helping their clients further reduce costs. In some cases, once a product has been designed, a company like Cisco Systems (Nasdaq: CSCO) will plug Flextronics directly into its online ordering system, so that orders flow straight to Flextronics, which then manufactures and ships the product, notifying Cisco on completion.

According to one estimate, the total electronic-goods market is about $600 billion worldwide, and is projected to grow at 22% for the next several years. Companies like Flextronics not only benefit from this growth in electronic product sales, but also from increased manufacturing outsourcing. As a result, earnings for the five CEM companies listed above are projected to grow by an average of 35% for the next two years. More and more companies are outsourcing to remain competitive, and some are even selling their factories to CEMs.

Flextronics bought some of those plants, which is one of the things that helped the company grow so quickly. In its fiscal year 2000 ending in March, the company reported $5.7 billion in revenues, 76% higher than the previous year. Income grew 84% to $198.8 million, and earnings per share (EPS) jumped 54% to $1.14 (both income and EPS figures exclude amortization and other one-time charges). Flextronics' sales grew at an average annual rate of 68.9% over the past five years, while EPS clocked in with 58.4% annual growth over the same period.

Two things make Flextronics stand out from its peers: its huge acquisitions and its recent lucrative contracts. Just in the past year, Flextronics signed a $400 million agreement with Compaq Computer to make motherboards for Compaq's servers; merged with the DII Group (a former top competitor) in the largest CEM merger ever; purchased manufacturing and repair services facilities from Cabletron Systems (NYSE: CS); and acquired Palo Alto Products International, a plastics processing company that will augment Flextronics' ability to make finished products like cell phones, that require plastic casing.

More importantly, on May 31st Flextronics closed a deal with Motorola to perform $30 billion worth of manufacturing over the next five years, the largest such agreement between a CEM and name-brand manufacturer to date. According to the Wall Street Journal, "By 2005, the companies expect Flextronics to make more than $10 billion of cellular phones, two-way pagers, set-top boxes, wireless-communications gear, and components," which is almost twice its current total revenue.

The company's financial statements are a bit convoluted, given its recent mergers, acquisitions, and new equity issues. Nevertheless, Flextronics' inventories and accounts receivable have remained steady, though the company's Rule Maker flow ratio is a bit high at 1.58. According to the company, return on invested capital (ROIC) has declined from 15% to 11.6%, partly as a result of its secondary offerings in October 1999 and February 2000, but the company's goal is to return to former levels as it deploys the new capital.

Finally, if you don't want to take my word for it, Flextronics has received some significant praise from other sources. The company's CEO, Michael Marks, was named a "Hero of American Manufacturing" by Fortune in March, and in a New York Times article in February, tech guru Roger McNamee picked the company as a stock for the decade. McNamee was effusive in his praise: "They have an exceptional management team and a wonderful reputation for having totally changed the rules. They are the Dell Computer of this decade."

Unfortunately, the company's recent deal with Motorola gave the shares a significant jump, and the company is not as attractively valued as it once was. Nevertheless, this sector can be volatile, so investors should keep an eye on Flextronics. Especially if they have a gadget-loving Dad contributing to its bottom line.

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