AlixPartners 2011 Global High-Tech Outlook

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As an industry, high tech weathered the recession better than most. Steady growth, across the board in all sectors, has been good news for the industry in 2010 and 2011. However, risks remain. Continued economic uncertainty, intense global competition, and high debt loads leave little room for error in strategy and execution. According to the AlixPartners 2011 Global High-Tech Industry Outlook¹, these conditions, combined with a sizeable gap between “winners and losers” and a diminished appetite for investing new equity capital, will likely lead to robust M&A activity in the industry through 2012.

INDUSTRY REVENUE TRENDS

Overall, the high-tech industry saw a modest 3% decline in revenue in 2009. Within the industry’s nine key sectors— channel distribution and retail), computer hardware, consumer electronics, electronics manufacturing services (EMS), internet/digital media, multi-sector echnology, semiconductors, software, and telecommunications— most experienced only moderate declines during the recession. Among these, the semiconductor sector fared the worst, with a 15% drop in revenue in 2009.

All sectors bounced back in 2010, sending overall industry revenue up 8.5%. In 2011, industry revenue continued that recovery, rising nearly 10.0% from the previous year (figure 1). Among the nine sectors, semiconductors rebounded the most, with 29.0% revenue growth in 2010.

• Overall industry revenue was up 8.5% in 2010 and nearly 10% in 2011
• Semiconductor and contract manufacturing revenues saw strong growth in 2010

In terms of profitability (measured as EBITDA margin), software and telecommunications generated the strongest results. Telecom, fueled by growth in mobile communications, accounted for 42.6% of the hightech industry’s $4.8 trillion in annual revenue in 2010, while contributing nearly two-thirds of the industry’s overall earnings before EBITDA (figure 2).

• Telecom accounted for 42.6% of the high-tech industry’s $4.8 trillion in 2010 revenue and two-thirds of overall industry earnings.

STRUCTURAL DISPARTIES

In an industry that demands aggressive investment and innovation, there are indications that the gaps between strong and weak performers will continue to expand. Industry-wide, top-quartile companies generated 4.5 times higher EBITDA margins than lower-quartile companies and invested four times more in capital expenditures as a percentage of revenue.

There are structural disparities at the sector level as well. Analysis of three-year average EBITDA percentage by sector from 2008 through 2010 revealed—unsurprisingly—that the more mature and/or challenged sectors generated the lowest EBITDA margins. Channel, for example, ranked lowest at 2.6%, just under contract manufacturing at 4.8%. At the high end, software produced a 32.0% three-year EBITDA average, closely followed by telecom at 31.0%. The industry average was 16.4% for the same period (figure 3).

• Top-quartile companies generated 4.5 times higher EBITDA margins than lower-quartile companies
• Top-quartile companies invested four times more in capital expenditures as a percentage of revenue
• Unsurprisingly, more mature and/or challenged sectors have the lowest margins

DANGER SIGNS

Despite relatively strong industry growth and financial performance overall, concerns remain about the financial viability of many high-tech companies across all sectors. According to the Outlook,44% of companies—who together produce more than half (56%) of all high tech industry revenues—still face a risk of financial distress or the likelihood of default or bankruptcy within two years if aggressive, corrective actions are not taken. This is down only modestly from 49% in 2009, at the bottom of the economic recession.

The consumer-electronics sector, in particular, has seen its risk of financial distress climb sharply in the past two years, largely due to weak demand and fierce competition leading to the erosion of profit margins. At present, more than 87% of consumer-electronics companies (by revenue) are at risk, up from 46.5% in 2009. Even in telecom, despite the sector’s overall strength, roughly three-quarters of sector revenues are generated by companies facing distress risk—largely because of the high debt loads taken on to expand their technological infrastructures and fund acquisitions (figure 4).

• 44% of accompanies still face a risk of financial distress
• That group represents some 56% of all high-tech industry revenues
• Consumer-electronics companies generating 87% of that sector’s revenues are at risk
• Roughly three-quarters of telecom sector revenues are generated by companies facing distress risk, despite the sector’s strong EBITDA performance

JOINING FORCES

The high-tech industry, more so than most other industries, faces a constant need to invest capital to drive product innovation and differentiation, and to keep up with the pace of new technology. “ Turning the technology crank”—especially in telecom, consumer electronics, and computer hardware—can be very capital intensive. As a result, even strong performers are often strapped with high debt loads. This reality, combined with the continued sluggish global economic outlook, will likely motivate aggressive consolidation.

Debt-to-equity ratios in the industry are falling in general from recessionary levels, however some sectors have “levered up”, most notably contract manufacturing (to fund acquisitions) and consumer electronics (to offset poor margins). Despite the telecom sector’s strong EBITDA performance, its debt-to-equity ratios remain high due to continuing capital needs and industry consolidation (figure 5).

• Debt-to-equity ratios are falling in general from the low point of the recession
• Contract manufacturing levered up largely to fund acquisitions, while consumer electronics did so largely to offset poor margins
• Software sector is adding lev erage, perhaps signaling potential for fur ther industry consolidation
• Telecom debt-to-equity ratios remain high due to continuing capital needs and industry consolidation

THE GLOBAL PERSPECTIVE

Geographic issues will likely have an impact on the strategies and performance of companies moving forward. EBITDA margins for companies based in Asia average just over 50% what they are for companies based elsewhere, indicating that Asian companies are willing to accept lower margins in the hopes of achieving market-share growth. This could put North American and European companies, among others, at a distinct disadvantage and could mean lower margins for the industry as a whole in the future.

Weaker balance sheets and the potential for lower margins could make the industry increasingly favorable for private-equity buyers. Private-equity firms specializing in smaller or distressed companies may find quite a few attractive turnaround situations and consolidation plays ahead. While many other industries are facing declining or no-growth scenarios, select investments in high-tech sectors with steady growth prospects could well represent a relatively low-risk investment opportunity for at least a portion of the huge amount of sidelined capital controlled by private-equity firms.

CONCLUSION

The high-tech industry weathered the recession well and shows steady growth opportunities overall despite continued turbulence in the overall global economy. Recent M&A activity—such as Google’s bid to acquire Motorola Mobility Holdings, AT&T’s bid to acquire T-Mobile USA, and Hewlett-Packard’s potential divestiture of its personal computer business—may well serve as a harbinger of things to come. Decisive action will need to be taken on several fronts, by companies and investors, as nearly half of high-tech companies continue to bear elevated levels of financial risk. The widening gap between winners and losers, combined with intense competition in maturing sectors, a diminished appetite for investing new equity capital, and heavy debt loads will likely lead to accelerated industry-wide M&A activity in the U.S. and in Europe through 2012. 

ENDNOTE

¹ The AlixPartners 2011 Global High-Tech Industry Outlook analyzed 1,195 companies in nine sectors: channel (distribution and retail), computer hardware, consumer electronics, electronics manufacturing services (EMS), internet/digital media, multi-sector technology, semiconductors, software, and telecommunications.

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