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The technology equipment manufacturing behemoth, the maker of Apple's (NASDAQ:AAPL) iPhones, and one of the most controversial firms in this sector, Hon Hai Precision (OTC:HNHAF), otherwise known as Foxconn Technology, is currently investigating claims that some of its employees have accepted bribes from its "supply chain partners." The company is based in Taiwan but does almost all of its manufacturing in China. The firm is known for its high quality of products but its reputation has been hit by the poor working conditions at its facilities that have created labor unrest, including more than a dozen suicides. In spite of these difficulties Foxconn is looking to expand its production base into a new market, itself struggling with labor difficulties, Indonesia.

Foxconn will facilitate this move into Indonesia by constructing a handset manufacturing facility. The local media has highlighted the names of PT Hartono Istana Teknologi, PT Industri Telekomunimasi and PT Telekomunikasi Indonesia as potential Foxconn partners in the country. Indonesia is the leading economy of Southeast Asia and an attractive market with a growing affluent middle class and a total population of 242.3 million (2011). The total number of SIM cards in use being more than 120% of the total population. That's how important a market Indonesia will be in the coming years. Indonesia spends more than $1 billion each year on importing mobile phones but Foxconn's decision to establish a facility is questionable because

a) The country is not known for manufacturing high tech equipment

b) There is little regulation on the import of cheap illegal mobile phones that have found a thriving market in Indonesia.

c) Indonesia's minimum wage levels are not particularly attractive for foreign investors

Because of these reasons Foxconn has not given any specifics about its investment plans.

Foxconn would rely on the Indonesian government's support to curb the imports of mobile devices as Foxconn cannot compete with the low prices of imported gadgets. The local authorities have been quick to respond to Foxconn's needs. The government is tightening its control on import of all mobile devices by implementing a new regulation, which came into effect with the New Year, whereby only registered buyers with the trade ministry will be allowed to import. Moreover, they are also required to have permits of foreign brands' principals or their manufacturers whose products they are selling and they must sell to at least three registered distributors, not directly to the retailers. If they fail to do so then their imports will be re-exported.

I believe that the government will eventually remove the primary hurdle in Foxconn's investment in the country and we will witness a sharp slowdown in the imports of knockoff phones. Other problems however remain. Indonesia doesn't have the infrastructure, such as skilled labor or supply chain partners, and as such Foxconn will have to build this from scratch.

Moreover, Indonesia is not particularly attractive in terms of cheap labor as minimum wages continue to rise and labor unions are becoming an ever stronger force within the country's political scene. The minimum wage levels were increased last year while the biggest hike has come in Jakarta where local authorities have increased minimum wages by 44% to $227 per month. In other words, Jakarta now offers almost as much minimum wage as the most affluent Chinese city Shanghai where minimum wage is $230 per month.

I'm tempted to believe this move by Foxconn is more of a political quid pro quo asked for by the Obama administration, since he has deep ties to Indonesia, in exchange for curbing the coverage of labor issues at its factories. Foxconn operates on extremely thin margins and is an amazingly efficient business so the more this deal has to be supported by legislation the more this smacks of international cronyism.

However, financially, the company continues to cross higher hurdles. In November, its monthly revenues increased by 16.4% (YoY) to a record height of $10.55 billion. Then in December, Foxconn beat its own record by achieving another monthly increase of 13.9% (YoY) to $10.83 billion. This has taken the total revenues of 2012 to a record level of $111 billion showing a 16.1% increase from last year, effectively outperforming analysts' estimates who had earlier predicted revenues of $100 billion. This is a company whose production will only get more efficient as it is looking to become a leader in assembly line robotics, deploying more than 30,000 in China in 2012. Its stated goal is to have 1 million such robots doing the work by 2014; shifting its human staff from assembling iPhones to assembling the robots themselves.

Like its Taiwanese rivals such as Quanta Computer (OTC:QUCCF) and Compal Electronics (OTC:CMPFF), the world's number one and number two contract laptop manufacturers, Foxconn is also witnessing falling levels of PC sales. But the robust demand of smartphones and tablets, particularly the iPhone 5 and iPad Mini, has completely offset the negative effects of PC demand. Although the exact figures aren't available, industry experts have identified that Foxconn earns 40% to 50% of its revenues from Apple. The robust December demand has taken most industry analysts by surprise as they had predicted a sequential fall in sales due to exceptionally strong numbers in November.

EWT

GMF

Stock 6M

13.8%

16.6%

P/E

14

12

Yield

2.02%

1.79%

Net Flows

$3.25B

$420M

Foxconn weighting

7.37%

1.58%

Sector Focus

Tech (56.43%)

Financials (18%)

Foxconn is represented in the Taiwanese ETF iShares MSCI Taiwan (NYSEARCA:EWT), along with Quanta and Compal, as well as SPDR S&P Emerging Asia Pacific ETF (NYSEARCA:GMF). In the last six months, both ETFs have benefited from the sharp rallies on the Asian exchanges, which began with the announcements of stimulus spending in China and the QE announcements in the U.S. and have outperformed the PowerShares QQQ Trust (NASDAQ:QQQ) since the Fed announced QE III back in September by 4.5% and 11.1% .

Source: Foxconn's Entry Into Indonesia An Odd Play