Too Much of a Good Thing: Motorola Hit Hard by Component Shortage

The chip shortage that wireless-phone maker Nokia (NOK Quote) disclosed two weeks ago is now hitting Motorola (MOT Quote). But there's a major difference: Nokia seems to be able to withstand the heat, while Motorola is melting.

"In a tight market, it comes down to a company's ability to manage inventory," says Bear Stearns equity analyst Wojtek Uzdelewicz. Motorola is less a victim of a tight components market than it is of poor inventory management, he says, echoing the sentiments of several other analysts. Citing the component shortage, the loss of a major order and other factors, Salomon Smith Barney downgraded Motorola today to outperform from buy and cut its price target on the stock from 200 to 120. The shares sold off sharply, closing at 87 11/16, down 16 13/16 or 16% from its Tuesday close of 104 1/2.

The risks to mobile-phone makers came into sharp focus a couple of weeks ago when Solectron (SLR Quote), the world's largest contract electronics manufacturer, announced that it probably will miss third-quarter revenue expectations because component supplies, including those for mobile phones, are the tightest they've been in five years.

But the issue goes deeper than the shortage of components such as printed circuit boards, surface acoustic wave filters, flash memory and tantalum capacitors. The shortage began last year and is expected to last well into next year.

Motorola posted first-quarter wireless-handset revenue of $3.2 billion, exceeding Wall Street expectations, but posted an operating margin for its handset unit of only about 1.5%, compared with forecasts of 7% to 8%, Uzdelewicz notes. Bear Stearns hasn't performed any underwriting for the company.

The company blamed "increased costs for certain components in short supply" as one of three reasons first-quarter operating profits declined to $49 million at the wireless unit, from $83 million a year earlier. "Motorola blamed earnings numbers on component shortages in the second quarter of 1999. But that's only a good excuse for two quarters. After that, it's a matter of poor forecasting," says an analyst who asked to remain anonymous so as not to be cut off from access to company information. A Motorola spokeswoman declined to comment beyond the company's April 10 press release on first-quarter results.

By comparison, Nokia, the leading mobile-phone manufacturer, dealt with inventory-management issues prior to recent supply shortages, and now feels considerably less pressure than its competitors, says Bear Stearns' Uzdelewicz. Nokia uses virtually the same internal components for its entire line of mobile phones.

This gives the company greater production flexibility because it meets shifts in demand by merely turning on or off internal software rather than ordering different components, he says. The company went from producing 15 million cell phones in 1996 to 78.5 million last year, says a Nokia spokewoman, who said the company dealt quickly with the logistics of transforming from a niche player to manufacturing diverse technologies for a customer base spanning 100 countries.

Milpitas, Calif.-based Solectron is struggling to meet prearranged contracts with original equipment manufacturers, let alone midquarter adjustments to orders, CFO Susan Wang says, but the company doesn't plan to play favorites with its largest clients. Solectron assembles mobile phones for Alcatel (ALA Quote), Ericsson (ERICY Quote), Kyocera (KYO Quote), Mitsubishi and Motorola, while Nokia outsources its manufacturing to Texas Instruments (TXN Quote) and Elcoteq Network of Helsinki, Finland, among others.

Nonetheless, companies facing inventory-management problems are likely to have even more trouble meeting market demand for mobile phones than better-organized competitors, as Solectron and other contract manufacturers report wide-ranging production delays. Even orders for simple components such as circuit boards are taking longer to fill -- eight to 10 weeks to construct, compared with the two to four weeks it usually takes under more normal circumstances, according to Wang. Companies such as Motorola, Ericsson and others may face increasing operating-margin pressure, as they struggle in this climate to get phones assembled to meet rising demands and to cope with inventory uncertainties.

Solectron is taking a variety of approaches to meet the needs of its OEM customers by encouraging new companies to enter the components manufacturing market, using alternative technologies and its status as an industry heavyweight to secure supply commitments, Wang says.

"I'm not sure of how deep the shortages really are, but I think it will affect everyone," says Jim Savage, a Thomas Weisel analyst. Thomas Weisel was a co-manager on Solectron's equity offering in July 1999.

"Those who have the best relationships with the supply base and have customers who share plans with their [contract manufacturers], such as Solectron, are likely to experience less pain," says Merrill Lynch analyst Jerry Labowitz. "However, demand is so strong across so many different product areas that it will not be uncomon to continue to hear about difficulties in procuring all the necessary components to meet any upside demand." Merrill Lynch took Solectron public in 1989 and led a secondary offering for the company last year.

Even mighty Nokia isn't totally immune. The company acknowledged in its recent first-quarter earnings report that if the components had been available, it would have seen even better results. Instead, the company had to settle for year-over-year sales growth of a mere 69%.