On Wednesday we sliced four more contenders from our high-growth study. That leaves us staring down six more. These six companies will either clear the hurdle and move to the finalist round, or we'll kiss 'em good-bye with nary a tear. Our finalist list already holds these nine companies:
Ariba (Nasdaq: ARBA)
Concord EFS (Nasdaq: CEFT)
eBay (Nasdaq: EBAY)
Genentech (NYSE: DNA)
Mercury Interactive (Nasdaq: MERQ)
Millennium Pharmaceuticals (Nasdaq: MLNM)
Openwave Systems (Nasdaq: OPWV)
Paychex (Nasdaq: PAYX)
Redback Networks (Nasdaq: RBAK)
We reiterated how we're cutting contenders in this round in Wednesday's column, so let's cut to the chase. Following is the list of six companies awaiting our decision:
We start at the end of the list.
With more than 22,000 employees, ADC is a networking equipment and software powerhouse that has shown impressive sales and earnings growth for more than the past five years. The company provides networking integration products across the communication spectrum, from telephone, Internet, TV, cable, wireless, enterprise networks to broadcast. Revenue the past three years has risen from $1.5 billion, to $2.1 billion, to $3.3 billion in 2000. Earnings per share have grown at a 57% annualized clip since 1995.
The stock has handily topped the S&P 500 the past decade, even though it has fallen from $50 to $10 in the past year, as it slid with most telecommunication and networking stocks. One fear is that customers are spending much less for network equipment given an economic slowdown. Aother fear is a potential glut of telecom companies, all fighting for customers. ADC does have the advantage of being more experienced than many competitors and of being well known. In fact, this share price could prove quite attractive in the long run.
Even so, we pass on ADC for the same reasons that we passed on Ciena (Nasdaq: CIEN) and Newport (Nasdaq: NEWP). It is far too difficult to predict where this company will be in 16 years -- will it continue to be leading-edge? What are the sustainable advantages that make its long-term dominance at least likely? We can't name those advantages with confidence, partly because the industry changes so rapidly. Therefore, as with most software companies, there is too much uncertainty for us to begin confidently investing here with a 16-year time horizon.
I've long admired Solectron. The company is a contract electronic manufacturer (CEM), meaning that it is contracted by other companies to make the electronic parts of today's gadgets, from cell phones to computers to network equipment. Cisco Systems (Nasdaq: CSCO) and Compaq (NYSE: CPQ) don't make all or even most of the parts that go into their products. These companies, and most technology giants, contract the production of several product parts to other manufacturers like Solectron and Flextronics (Nasdaq: FLEX). Outsourcing can lower a company's costs and investments and improve margins.
Contract electronic manufacturers have enjoyed a surge of business over the past decade as technology products in general surged. Solectron has grown sales 47% annualized the past five years, and earnings per share grew 31% annualized. Sales in the first quarter of 2001 neared $5.7 billion, slightly more than all of 1998 sales. The stock has been a strong outperformer the past decade.
With a chance for revenue to top $20 billion in the next 12 months, you might think that Solectron would have a market value well above that. However, its current market value is $16 billion, or equal to its past 12-month sales. Solectron is a volume business, not a high-margin business. Its operating margin is only 5%, and its profit margin is 3.5%. This indicates that there is not a serious moat around the business protecting it from competition. Several contract manufacturers compete for clients, and price is a big bargaining chip. That doesn't mean that it's a poor business -- it is a great volume business, as long as volume remains high and continues to grow.
We pass on Solectron, however, because it doesn't get near our margin and cash flow benchmarks, and because it has $4.9 billion in long-term debt, which is more than its cash and equivalents. Also, the company is at the whim of other, larger companies. If demand falls for products in a given technology sector, Solectron stands to get hit, too -- and a glut of telecom and networking products could hit it hard. This makes the business less predictable because it adds more moving parts and Solectron doesn't have an ability to create demand for its own products.
To close, remember that four companies also remain on the docket for analysis by you -- Fools in the community! These companies are:
Corning (NYSE: GLW)
Enron (NYSE: ENE)
Broadcom (Nasdaq: BRCM)
Medtronic (NYSE: MDT)
If you would like to see these companies considered for the finalist list, post your arguments for any of them on the Drip Companies board.