Sharp's LCD Division gets "Fox"y
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Sharp Corp (NASDAQOTH: SHCAY.PK), the manufacturer of electronics products worldwide, has finally raised its white flag and has accepted the assistance of a Chinese rival. Hon Hai Precision Industry Co., which includes the well-known Foxconn – the component manufacturer for popular consumer electronics including the Apple (NASDAQ: AAPL) iPhone, Amazon.com's (NASDAQ: AMZN) Kindle Fire, and Nintendo (NASDAQOTH: NTDOY.PK) Wii – has purchased a 10%, $800 million stake in the ailing Sharp Corp in an attempt to alleviate pressure on its troubled LCD panel division.
The news highlights the ever-changing Japanese electronics industry landscape, which has been recently barraged from all sides with the 2011 Tohoku earthquake and tsunami, as well as increased competition from increasingly technologically advanced Chinese counterparts. Hon Hai’s investment in Sharp shows that the electronics hub is increasingly being shared by the once-rival nations, and marks the continued shift away from the large, hierarchical, and vertically-integrated structures that once represented Japanese electronics manufacturers.
Sharp, as have other electronics designers and manufacturers including Sony, LG, and Samsung, have witnessed a huge drop not only in the demand for LCD panels, but other consumer electronics as well.
Sharp’s own revenues have fallen by 3.4% over the past five years, which is due primarily to the 57% drop in revenues stemming from the sale of LCD panels. To maintain buoyancy, the corporation has not only had to cut total R&D expenditures (which could hurt competitiveness over the mid-term), but has also increased its debt burden; total borrowings, including both long and short term debt, has increased by more than 40% since 2007. Through the combination of reduced sales, the subsequently lower operating margin, and the increased interest expense, interest coverage ability (operating income divided by net interest expense) has decreased by more than 93% over the same time period.
The issues in the LCD business, which is by no means isolated to Sharp, is very reminiscent of the current problems experienced by the automotive industry in the European sector.
- Dramatic Overcapacity: Sharp invested $12 billion in a new factory opening in 2009, and announced earlier this year that the factory would run at half capacity throughout most of 2012. Large fixed costs have continued to plague the division, and there are concerns about a major plant write-down, which would be extremely unfortunate considering the plant’s age.
- Cheaper Competitors: The price of large LCD panels has been on a consistent decline since at least the end of Q3 2010. The decline has been fueled by multiple drivers including more competitor know-how of the technology, increased industry penetration (most of those who want an LCD TV have probably already purchased one) and reduced demand, and more consumer choices from smaller and lower-priced alternatives. Nearly 90% of the large-sized flat screen LCD panel business is devoted to PC and TV manufacturing, and reduced consumer spending in these areas over the past several years has required discount prices to prevent huge inventory build-ups.
- Hierarchical Structures: In an attempt to solidify their positions as industry captains, many Japanese electronics enterprises have often shunned the notion of establishing joint ventures with foreign competitors. The Japanese natives have historically been vertically integrated behemoths, handling everything from product design, manufacturing, and sales/marketing in-house and are now being forced to slim down to remain competitive.
In both the electronics and automotive industries, the obvious solution has been the pooling of resources. Hon Hai’s own LCD division has struggled not only with reduced demand and subsequent operational losses, but also with relatively weaker technological know-how. The cash infusion into Sharp (similar to GM into Peugeot) should allow both corporations to share design ideas, component parts, and manufacturing capacity.
As Hon Hai’s Foxconn division is the notorious manufacturer of the popular “i"-prefixed products, many will probably wonder how the investment will affect Apple. Apple has long wanted to make a big splash into the TV business – much more than its TV-attachable Apple TV product – and has hinted in its most recent earnings call that a much bigger project is on the horizon. The highly anticipated “iTV” (name not yet known with certainty), which analysts expect may utilize Sharp’s LCD technology, would undoubtedly benefit from increased Hon Hai vertical integration.
If such expectations are accurate, such an increase in panel production will only partially alleviate Sharp’s troubles. LCD panels comprise a relatively small percentage of the corporation’s total output, and it is still plagued with stagnant demand in home appliances, as well as dramatically dropping sales in both information equipment and other small electronics, which have experienced revenue slumps of 37% and 43%, respectively, between 2007 and 2011. The Hon Hai investment is but a first step in a long path of total operational correction.
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