Foxconn-Sharp Deal Will Give Apple Greater Control Over Its Supply Chain

| About: Apple Inc. (AAPL)
This article is now exclusive for PRO subscribers.

Foxconn, one of Apple's (NASDAQ:AAPL) leading contract manufacturers, announced recently that it will seek to renegotiate a lower price for its stake acquisition in Sharp following a plunge in the latter's share price. Sharp's shares slumped to their lowest in almost 37 years after the company guided for an annual loss of 250 million yen this year, bigger than its current market capitalization.

While Sharp will wants the deal to go through for the lifeline it provides in terms of cash and technological know-how to compete with Samsung, Apple needs Sharp to return to strength as well. If Sharp succeeds in staging a turnaround with Foxconn's help, not only does it ensure the survival of one of Apple's key suppliers, but also helps the latter reduce its dependence on Samsung and foster greater competition in its supply chain.

Over time, this will help Apple protect its margins, which could come under pressure due to the extremely competitive dynamics of the mobile industry. We have a $700 price estimate for Apple's stock, about 12% ahead of the current market price.

Foxconn/Sharp to take on Samsung

Hon Hai's Foxconn is one of the leading assemblers of Apple's mobile devices, including the iPhone and the iPad. Sharp, on the other hand, is a struggling supply chain partner for Apple. It was rumored to have fallen significantly short of Apple's expectations ahead of the iPad's launch earlier this year, manufacturing only 2.7 million Retina display panels for the new iPad.

Under the terms of the deal, Foxconn will not only acquire a stake in Sharp, but also gain a 46.5% ownership in Sharp's LCD plant in Sakai, Japan. Both will jointly run operations at the Sakai plant and lay a proportionate claim on the revenues. Through this deal, Foxconn hopes to gain greater access to the supply of components that go into the assembly of the iPhone, the iPad and future orders of a much-rumored Apple TV as well. Sharp, for its part, gets a much-needed injection of cash and the expertise of a partner which has had much success in large-scale manufacturing.

If the deal goes through, it will be a good development for Apple as well since it ensures the survival of one of its key supply chain partners. It also gives Apple the opportunity to gradually decrease its dependence on Samsung, which is not only one of Apple's major supply chain partners but also its chief competitor. Samsung and Apple are locked in smartphone patent battles around the world and are also competing fiercely for a greater share of the rapidly growing smartphone market. The latter could therefore be looking to diversify.

Samsung, well-known for its LCD flat panel screens, is however a key supplier of the retina display panels that go into the iPhone and the iPad and a very strong contender for securing orders of the rumored Apple TV's display panels as well. Sharp, on the other hand, hasn't been able to meet Apple's quality requirements in terms of large-scale manufacturing and has therefore ended up playing second fiddle to Samsung's manufacturing might.

But, together with Foxconn, Sharp could have a greater leverage in negotiating the prices of parts and gain know-how in manufacturing displays used in Apple products on a wider scale without compromising on quality. If Foxconn-Sharp can form a partnership potent enough to compete with Samsung on a sustained basis and meet Apple's lofty quality standards, Apple can finally hope to reduce its dependence on Samsung and foster greater competition in its supply chain. This will help Apple negotiate better and secure supplies for its products at a lower cost, lifting its overall gross margins. This is especially true for the new iPad, which is costlier to produce than its predecessors due to the expensive retina display and LTE support.

Disclosure: No positions