The 2012 high tech industry

© 2012 AlixPartners, LLP

OCTOBER 2012

Winner Takes AllINSIDE:

Growth, Profitability, and Shareholder ReturnsBusiness Models and Overhead Costs

Significant Regional DifferencesBalance-Sheet Strain

The 2012 AlixPartners Global Telecom and Technology Outlook

Winner Takes All2

© 2012 AlixPartners LLP

he once high-flying high-tech

industry is experiencing a

dramatic shift: growth rates

have dropped to just 2%,

and the industry’s market

value is underperforming broad market indices.

For many companies, according to The 2012

AlixPartners Global Telecom and Technology

Outlook1, this environment requires significant

action. Poorer performers face the biggest

challenges; the analysis shows they’ll need

to cut up to 30% of their sales, general &

administrative (SG&A) costs. Even stronger

performers will need to change their operating

models radically, including transitioning to

“asset-light” operating models and cutting

overhead costs by as much as $50 billion in

total. High-tech companies across the industry

will need to act now to remain competitive in

an increasingly polarized market where, more

and more, the winner takes all.

T

According to the study, after years of double-

digit annual revenue increases, the $5.5 trillion

global high-tech industry has experienced

a dramatic cooling of top-line growth rates.

Industry revenues grew just 2% over the

12-month period concluding June 302,

compared with an average 10% growth rate

during the two-year period of 2009 to 2011

(figure 1). Meanwhile, the three sectors that

make up 20% of the overall industry – consumer

electronics, telecommunications equipment

and semiconductors – saw revenues drop by

8%, 1%, and 3%, respectively.

Growth, Profitability, and Shareholder Returns

Channel (distribution & retail) Computer Hard. & Elec. Equip. Consumer Electronics Contract Manufracturing Software

Technology Cos Internet/Digital Media Semiconductors Telecom Equipment All High Tech Telecom Operators

LTM is June 2011 - June 20121

35%

30%

25%

20%

15%

10%

5%

0%

-5%

-10%

-15%2009 2010 2011 LTM 2009 2010 2011 LTM

1For companies filing Q2 ‘12 results (~90% of companies by revenue) Source: CapIQ, AlixPartners Analysis

FIGURE 1: Industry Revenue, Percent Change YoY

1 The 2012 AlixPartners Global Telecom and Technology Outlook studied 1,173 companies across 10 major high-tech industry sectors: telecommunications operators, telecommunica-tions equipment, semiconductors, Internet, contract manufacturing, computer hardware, consumer electronics, software, multi-sector technology and channel (distribution and retail). Public economic data and forecasts were also used in the study.

2Based on the reported second-quarter performance of 90% of the companies included in AlixPartners’ analysis.

Winner Takes All3


Profit margins in the industry have also been

squeezed over the past year. Operating-

income margins have shrunk by nearly 6%

across all sectors since 2010, with declines of

approximately 50% in consumer electronics, 30%

in semiconductors, 20% in telecommunications

equipment, 15% in contract manufacturing and

6% for telecommunications operators. Currently,

telecom operators generate approximately half

(47%) of industry operating profits on the back of

only about one-third (34%) of industry revenue

(figure 2). However, if margins in this sector

continue to erode, the trend could likely have a

substantial impact on overall industry profitability

– and result in mediocre shareholder returns.

At first glance, it appears that the high-tech

industry as a whole outperformed broad

market indices in terms of market capitalization

(excluding dividends) this year through August

31. But, if we exclude just one company, Apple,

Inc., we see that market-cap for the high-tech

industry grew just 6% during that period. That

trails both the NASDAQ Composite Index and

FIGURE 2: Revenue vs. EBITDA Margins, 2011

Source: CapIQ, AlixPartners Analysis

35%

30%

25%

20%

15%

10%

5%

0%$0 $200 $400 $600 $800 $1800

EBIT

DA (%

)

Sector Revenue ($B)

Software

Internet Semiconductors

Computer HardwareComputer Electronics

Contract manufac. Channel

Multi-Sector Tech

Telecom Communication Equipment

Telecom Operators Revenue: $1.8B

S&P 500 averages, which grew 16%

and

8%, respectively, in the same period.

The study also finds that for the period

between January 1, 2011 through

August 31 of this year, companies

in the most-profitable quartile (defined by

earnings before interest, taxes, depreciation

and amortization, or EBITDA) of their sectors

were 73% more likely to outperform the

S&P 500 average than those in the bottom

Business Models and Overhead Costs

EBITDA quartiles.

To combat the considerable challenges to

revenue growth, profitability, and shareholder

returns, many companies urgently need to

adopt “asset-light” operating models and

reduce costs, including SG&A. The study finds

that while average industry return on capital

employed (ROCE) has remained steady at

about 11%, over the last five years companies

Winner Takes All4


with leaner asset models, including many

software and Internet companies (where

sector ROCE levels are currently 22% and 17%,

respectively), continue to show higher overall

returns. Conversely, “asset-heavy” sectors,

such as consumer electronics and computer

hardware (with ROCE levels of 5% and 8%,

respectively), continue to be challenged.

In this environment, the most successful

tech players are aggressively outsourcing

manufacturing and supply-chain operations,

thus reducing capital employed, often with

the added benefit of also reducing risk and

exposure to technical discontinuities.

The study also finds that overhead costs as

a percentage of revenue have jumped by as

much as 17% since 2010 in sectors such as

semiconductors (+ 17%), computer hardware

(+ 14%), and consumer electronics (+ 4%) (figure

3). As a result, in total, companies in the high-

tech industry need to trim overhead costs by as

much as 5%, or $50 billion—or the equivalent

of about 1% of overall industry revenues. Poorer

performers, such as many companies in the less-

profitable consumer-electronics and telecom-

hardware sectors, face an even higher hurdle.

Those companies may need to cut overhead by

as much as 30% to be cost-competitive going

forward. High overhead costs may have been

permissible when the industry was booming,

and they may still be absorbable by some high-

flying individual companies today, but for many

if not most companies, that’s no longer the case.

Among the four major regions studied in the

Outlook, the European market is enduring the

slowest compounded annual revenue growth

rate—just 3% over the two-year period from

the end of 2009 through the end of 2011,

compared with the global industry average

of 10% during the same period. In contrast,

compound industry revenue growth over the

same period in Asia-Pacific, the Middle East

and Africa (MEA), and North America averaged

12%, 12%, and 14%, respectively.

FIGURE 3: SG&A as Percent of Revenue

35%

30%

25%

20%

15%

10%

5%

0%

2007 2009 20112008 2010 LTM


Channel (distribution & retail) Consumer Electronics Software Internet/Digital Media Telecom Communications Equipment Telecom Operators

Computer Hardware & Electronic Equipment Contract Manufracturing Technology Cos Semiconductors All High Tech

Significant Regional Differences

Winner Takes All5


Regional differences may grow even more

pronounced in the future, in part because

North American companies are exhibiting

a greater focus on the more innovative,

profitable technology spaces, while Asian

players continue to “commoditize” more

traditional areas, such as consumer electronics.

According to the study, Asian-based companies

generated nearly half (49%) of industry revenue

in 2011 but only about 37% of industry EBITDA.

North American companies, on the other hand,

generated 33% of industry EBITDA last year

on 30% of industry revenues; for European

companies, the comparable numbers were

22% and 17%, and for rest-of-world companies,

8% and 4%, respectively.

We anticipate that the current, raging “battle

of the mobile devices and operating systems”

will have both near-term and long-term

consequences for the industry, particularly for

European players ranging from semiconductors

to telecom operators, telecom equipment

manufacturers, and consumer electronics.

Meanwhile, North American companies

today command a much higher market share

globally in three of the industry’s four most

profitable sectors: software (74%), Internet

(76%), and semiconductors (48%). European

companies command a relatively high market

share in the telecom-operators sector (33%),

while Asian companies have a relatively high

market share in four of the six least-profitable

sectors: consumer electronics (92%), contract

30%

20%

10%

$1.0 $2.0

Higher Value Sectors

Lower Value Sectors

EBIT

DA M

argi

n, %

Global Revenue, $ Trillions

Software

InternetSemiconductors

Hardware

Cons. Electronics

Contract manufac.

Channel

Multi Techology

Telecom Equipment

Telecom Operators

Share of Revenue by Region:

AP NA EUR ROW

LEGEND

Bubble Size is Sector Revenue


FIGURE 4: Regional Performance and Share of Revenue by Region (FY 2011)

Winner Takes All6


manufacturing (82%), multi-sector technology

(74%), and computer hardware (62%) (figure 4).

Meanwhile, last year, North American high-tech

companies in general (with an average EBITDA

margin of 23%) and European companies

(with an average EBITDA margin of 27%)

were significantly more profitable than Asian

companies, which recorded an average EBITDA

margin of just 15%.

As a whole, the industry continues to feel the

strain of high leverage and debt levels. Debt-

to-equity levels in such sectors as consumer

electronics (led by recent multi-billion-dollar

debt issuances by Sony Corp. and Sharp

Corp.) and contract manufacturing (led by Hon

Hai Precision Industry Co.’s recent $8 billion

offering) have been climbing sharply. By the

same token, interest coverage is falling in

many sectors, most notably in semiconductors

(where coverage has fallen from about 23

times interest in 2010 to about 18 times interest

during the 12-month period ending in July of

this year) and consumer electronics (where

coverage has fallen from about 12 times interest

in 2010 to under eight times interest today).

As a result, companies generating more than

85% of revenues in the consumer-electronics

sector today face risk of financial distress

(defined as the possibility of insolvency within

two years, absent aggressive intervention).

The same holds true for companies generating

more than 70% of revenues in the telecom-

Balance-Sheet Strain

FIGURE 5: Percent of Revenue Generated by Companies Facing Distress1

1Companies with an At-Risk or High-Risk rating. Source: CapIQ, AlixPartners Analysis

50%

0%

2007 2009 20112008 2010 LTM

2007 2009 20112008 2010 LTM

All Industry

Channel (distribution & retail) Consumer Electronics Software Internet/Digital Media Telecom Communications Equipment

Computer Hardware & Electronic Equipment Contract Manufacturing Technology Cos Semiconductors Telecom Operators

100%

80%

60%

40%

20%

0%

Winner Takes All7


As the technology industry continues to

polarize, it is increasingly becoming a “winner-

takes-all” industry. As Apple and a few other

top-performing companies generate the lion’s

share of market-cap growth for the entire

industry, all companies will need to cut costs

and move to more agile, “asset-light” business

models” to remain competitive. Future

“winners” will need to succeed in these efforts

while simultaneously innovating and deriving

real value from CapEx and R&D expenditures.

Conclusion

Winner Takes All8


About AlixPartners

AlixPartners conducts a broad range of surveys and research in industries around the globe.

To learn more about our publications, or to contact the AlixPartners professional nearest you, please visit

www.alixpartners.com.

AlixPartners, LLP is a global business advisory firm offering comprehensive services in four major areas:

enterprise improvement, turnaround and restructuring, financial advisory services, and information

management services. The firm was founded in 1981 and can be found on the Web at www.alixpartners.com.

For more information, please contact:

Eric BenedictManaging [email protected]+44 20 7098 7437

Karl RobertsManaging [email protected]+1 (213) 437-7155

Michael WeyrichManaging [email protected]+44 20 7098 7413

Yung ChungManaging [email protected]+82 10 9437 2750

Masahiko FukasawaManaging [email protected]+81 3 5533 4850

Winner Takes All9

© 2012 AlixPartners LLP© 2012 AlixPartners LLP

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The 2012 high tech industry

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