Sharp needs Hon Hai ties, if only for Apple

Electronics giant must stay alive to keep parts flowing

by Tim Culpan and Mariko Yasu

Bloomberg

Taiwan billionaire Terry Gou built a manufacturing empire that assembles iPhones and iPads. His Foxconn Technology Group may be key to ensuring Sharp Corp.’s survival and a stable supply of components for Apple Inc.

Sharp’s shares collapsed to their lowest in 37 years in Tokyo on Friday and its bonds fell after the maker of Aquos TVs forecast an annual loss of ¥250 billion, bigger than the company’s market valuation. That slump prompted Foxconn to announce Friday it will seek a lower price for its 9.9 percent stake while pledging to forge ahead with the deal.

Foxconn wants a stake in Sharp to secure access to the latest technology for parts used by its biggest customer, Apple. In offering a lifeline, Gou is betting that Sharp will continue to provide it with key components for the iPads and iPhones that Foxconn assembles, while ensuring one of Apple’s important suppliers survives.

“Apple needs Sharp,” said Alberto Moel, an analyst at Sanford C. Bernstein in Hong Kong. “Sharp’s capacity is large enough that if it were taken offline, it could hurt Apple.”

Gou, the founder and chairman of Foxconn Technology Group, in March engineered a ¥133 billion investment that will give his company a stake in Sharp while injecting ¥66 billion of his own cash into its display affiliate. A plunge in Sharp’s shares prompted Foxconn to announce last week it will renegotiate the deal, seeking more favorable terms.

The stakes are high for all parties involved. In addition to a new iPhone, a new, smaller iPad and perhaps an Apple TV are expected to revive profits for Apple after net income and sales missed estimates for the second time since 2003 in the quarter that ended in June.

Chief Executive Officer Tim Cook has said TVs are an area of “intense focus” for Apple.

The company is working on a television that may be unveiled this year and released in 2013, according to Gene Munster, an analyst at Piper Jaffray Cos.

If Apple needs Sharp, the question now is whether Foxconn fix Sharp to advance its own ambitions for growth. Foxconn and its clients compete with Samsung Electronics Co., the world’s biggest maker of phones, flat panels and flat-screen televisions globally. Gou figures a closer alliance with Sharp and its technological expertise will put Foxconn on a better competitive footing with Samsung.

“The Sharp deal will help us to defeat Samsung,” Gou, 61, told investors on June 18 at the annual meeting of Hon Hai Precision Industry Co., Foxconn’s flagship and the business that does Apple assembly.

Hon Hai gets about 34 percent of its revenue from manufacturing the iPad and iPhone, according to July 2 estimates from Jih Sun Financial Holdings Co. Yet some note that Foxconn having a bigger say in Sharp’s operations may not result in Sharp boosting sales to Apple, nor provide the profits investors are looking for.

Shares of Sharp dropped 5.7 percent to ¥181, the lowest since October 1974, in Tokyo on Monday, after plunging 28 percent Friday. The stock has fallen 73 percent this year and is the worst-performing member of the Nikkei-225 stock average.

Sharp’s “stock price decline shows investor skepticism that Foxconn can actually help turn the company around,” said Vincent Chen, an analyst at Yuanta Securities Co. in Taipei. “We can see that Foxconn being closely connected to Apple is no guarantee that Sharp will be able to secure any extra orders.”

One of the paradoxes of the Apple-Sharp-Foxconn relationship is that despite intense demand from Apple for its components, Sharp’s liquid-crystal display division loses money. Turning around that division, which suffers from industrywide overcapacity that is driving down prices, may be the sticking point in returning the company to profit. Worldwide TV shipments, the major user of display panels, fell about 8 percent in the first quarter as sales of LCD models dropped on an annual basis for the first time, research company DisplaySearch, part of NPD Group, said June 20.

“Sharp needs to show that it can fix its LCD unit,” said Keita Wakabayashi, a Tokyo-based analyst at Mito Securities Co. “It should be able to improve its small-to-medium-size panel business because they are used in tablets and smartphones, where demand is growing.”

Sharp said Aug. 2 it will cut 5,000 jobs as it reels from lower TV prices and demand, and a yen trading near its postwar high, reducing the value of overseas earnings. The company’s net loss was ¥138.4 billion in the three months that ended June 30, widening from ¥49.3 billion a year earlier, it said.

Even after shares plunged more than 60 percent below the price both sides agreed to in March, Sharp and Foxconn, which employs 1.2 million workers on assembly lines in China, remain committed to the investment. Foxconn plans to renegotiate to lower the ¥550-per-share it had originally agreed, Simon Hsing, a spokesman for Hon Hai, said Friday.

Miyuki Nakayama, a spokeswoman for Osaka-based Sharp, declined comment on whether the company has been approached to renegotiate terms of the ¥67 billion investment Foxconn originally agreed to make.

When Foxconn Technology Group agreed to buy its stake in Sharp, Gou also put ¥66 billion of his own money into an LCD venture with Sharp. The two groups have already agreed to collaborate, with Hon Hai planning to make the Japanese company’s smartphones for sale in China, the world’s biggest market for such devices, and Gou saying June 18 the companies will cooperate on assembling high-definition TVs.

Investors and ratings companies are not impressed. Credit Suisse Group AG and JPMorgan Chase & Co. downgraded their ratings on Sharp. Standard & Poor’s cut its ratings to BBB from BBB+ and is still keeping the company on watch negative, meaning further downgrades are possible. Fitch Ratings also said the company’s ratings may be cut to junk level in six to 12 months.

In July, the cost to insure Sharp’s debt against default in the short term outstripped that for the longer term for the first time, a signal investors have concerns about the company’s ability to repay debt. The company’s net debt to shareholders’ equity was 209.44, higher than its local peers in the country, according to data compiled by Bloomberg.

There could be more than just electronics in the Sharp-Foxconn deal. The Taiwanese firm may be able to use Sharp’s home appliance and solar businesses to move into China and take on Samsung, a key supplier and competitor of Apple.

Sharp’s health and environmental division makes white goods, including refrigerators, ovens and washing machines. Its information equipment group, which supplies cash registers, makes point-of-sales machines and printers.

These two are the company’s only profitable businesses and accounted for about 31 percent of sales in the fiscal first quarter, according to company data.

“What needs to be focused on going forward is whether Hon Hai and Sharp will still have an alliance even if they can’t agree on the terms,” said Masahiko Ishino, an analyst at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “It won’t be positive news for Sharp if the alliance isn’t maintained.” Nor for Apple.