The past 10 years have been a wild roller-coaster ride for Solectron (NYSE:SLR) shareholders. Gunned up to unsustainable valuations in the midst of the tech bubble, Solectron got crushed along with most other technology companies. Now, though, these shares could be something of a bargain.
Its financial performance in the third quarter certainly wasn't blockbuster. Revenue dropped about 14% from the prior year (nearly 6% from the previous quarter), and reported operating income was soft even when some restructuring charges were added back.
The computing and communications businesses performed all right, each growing compared with the second quarter, but the networking and consumer businesses were quite weak. On the consumer front, Solectron's 3G handset business declined considerably ($150 million lower than last year), and the set-top box business was also soft. Revenue from major customer Cisco (NASDAQ:CSCO) was down about 23%, though business from Nortel (NYSE:NT) was flat.
But it's not all bad news.
The company continues to build up its medical device business, and management seems committed to exploiting this potentially profitable opportunity. What's more, the company has signed a major agreement with Lucent (NYSE:LU). Though management would not go into details, it did indicate that the magnitude of the deal was such that Lucent would become a "major customer" -- perhaps on par, then, with the likes of Cisco and Nortel.
What intrigues me about Solectron is that the balance sheet is in pretty good shape and the company has been producing considerable cash flow. Liquidity is certainly no issue, because Solectron produced about $700 million in free cash flow over the past four quarters and ended the third quarter with a positive cash/debt position of nearly $1 billion. What's more, an ongoing restructuring effort should improve margins down the road.
I don't expect the technology sector as a whole to roar back to life. In fact, many sectors like semiconductors and networking are barely back on their feet. But, over time, I think we will see growth and improvement across the board, and as companies increasingly appreciate the benefits of outsourcing, Solectron will recover.
Turnarounds are tricky to value, and this is no exception. While earnings are weak now and guidance for the next quarter is a bit soft, the enterprise value-to-free cash flow and price-to-book ratios are intriguing, at 5 and 1.4, respectively. With strong customer relationships and a very strong balance sheet, I think Solectron has what it will take to recover -- although I have no idea how long that will take.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
