SCI, Sanmina Join to Escape Dreaded Niche Label

And then there were four.

SCI Systems' (SCI - Cramer's Take - Stockpickr) decision Monday to be acquired by fellow contract electronics manufacturer Sanmina (SANM - Cramer's Take - Stockpickr) for $4.1 billion in stock catapults the companies into the ever-shrinking big league of contract manufacturing. The deal probably won't do much to turn either company's flagging stock around in the short term. But in the long run, most observers are seeing it as an important move to gain crucial size and diversification.

Sanmina claims that the combined company will have sales above $14 billion and 100 plants around the world. That puts it in the same league as a triad of massive electronics manufacturing services, or EMS, companies: Solectron (SLR - Cramer's Take - Stockpickr), Flextronics (FLEX - Cramer's Take - Stockpickr) and Celestica (CLS - Cramer's Take - Stockpickr). That's key for Sanmina and SCI Systems. In the world of contract manufacturing, where the competition often shakes out according to whether companies have the capacity to handle the largest and most profitable outsourcing deals, size matters quite a bit.

Four on the Floor
Company	Manufacturing Capacity	2000 Sales
Solectron (SLR:NYSE)	15.7 million sq. ft.	$14.1 billion
Sanmina/SCI Systems	12.1 million sq. ft.	$12.3 billion
Flextronics (FLEX:Nasdaq)	12.6 million sq. ft.	$12.1 billion
Celestica (CLS:Nasdaq)	5.3 million sq. ft.	$9.7 billion
Source: Lehman Brothers, the Companies

"The stakes have been elevated here," says Patrick Parr, an analyst at ABN Amro. "You need to be of a certain size to compete for the largest deals. Now, there are only four companies who can survive on equal footing. The rest, they'll be outflanked in terms of going for the largest deals." (ABN Amro hasn't done recent underwriting for these companies.)

SCI Systems was lately up $1.38, or 5.5%, to $26.55, while Sanmina was falling $2.27, or 10.3%, to $19.87.

Calling EMS

As with the rest of the industry, both SCI Systems and Sanmina have seen their capacity utilization decline amid order cancellations by major customers struggling with the tech slowdown. Merging the two operations won't necessarily fix that problem. "Combining two underutilized companies doesn't mean that you get better utilization," says A.G. Edwards analyst Tony Boase. "They're going to have to do a significant amount of cost-cutting and consolidation of their operations."

Contract Killing

The deal isn't solely about scale, then. It's just as much about diversifying away from niche markets. In Sanmina's case, that niche was the market for high-end communications systems, which the company produced for customers like Cisco (CSCO - Cramer's Take - Stockpickr), Nortel (NT - Cramer's Take - Stockpickr), Alcatel (ALA - Cramer's Take - Stockpickr) and Nokia (NOK - Cramer's Take - Stockpickr). SCI Systems' niche was PC circuit boards.

As it happens, both of those end markets have been hit hard at the same time. But the hope for the future is that each can counterbalance the other, and provide some measure of stability.

"But if you were to focus on the next couple of quarters, I wouldn't buy any of these stocks," says Boase. "These guys will continue to struggle as long as the end markets do."