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SMARTPHONES: Foxconn Rises on Apple, Huawei and Xiaomi

Bottom line: Foxconn's taking of the smartphone manufacturing crown from Samsung reflects the resurgence of Apple and rises of Huawei and Xiaomi, and could ultimately force other brands to use such third-party producers.

Today we'll take a step back from the usual name-brand smartphone rankings to look at a new report that shows that Taiwan's Foxconn (HKEx: 2038) is emerging as one of those "industry leaders you never heard of", quietly supporting some of the fastest-growing names. That's the big takeaway from the latest figures from data tracking firm IDC, which show that Foxconn officially passed global titan Samsung (Seoul: 005930) in last year's final quarter to become the world's biggest smartphone manufacturer.

Most industry insiders already know Foxconn and its parent, Hon Hai, because of their longtime relationship as a key producer of iPhones for Apple (Nasdaq: AAPL). But the Taiwan company also counts Xiaomi as a major client, as that company experiences a resurgence in its fortunes after a couple of years in the dark. Foxconn also makes phones for Huawei, which is also doing quite well on the global smartphone scene at the moment.

Moving in the other direction is Samsung, which makes its own smartphones and in last year's fourth quarter officially ceded the global smartphone crown to Apple. So in that sense, Foxconn's overtaking of Samsung on the smartphone manufacturing charts is probably a natural progression, especially given the recently rising fortunes of Foxconn customers Xiaomi and Huawei.

All that said, let's zoom in on the latest headlines that don't show any data but simply say that Foxconn overtook Samsung to become the world's largest smartphone manufacturer in the final three months of last year. (press release) The other big news from that data showed Oppo, also a leading brand, dropping from the third biggest manufacturer to the number four spot. It was overtaken by another Taiwan third-party manufacturer, Pegatron (Taipei: 4398) which also counts Apple as a client.

On an annual basis, Samsung still came out as the world's biggest smartphone maker for all of 2017. That's consistent with last year's full-year data as well, which showed that Samsung was the leading brand for the year, even as it lost the actual title in the fourth quarter to Apple as the latter rolled out its latest iPhone.

Good for Foxconn?

So, what does all this say about Foxconn and the industry in general? Certainly one of the biggest trends appears to a consolidation of the sector by third-party manufacturers like Foxconn and Pegatron, which are unknown outside industry circles but are the driving force enabling the rise of names like Xiaomi and even Huawei. Such companies provide the big brands with flexibility in terms of production, and also allow the big names to focus on more important things like product design and promotion rather than more mundane matters like manufacturing.

But big business doesn't definitely guarantee big profits, as both Foxconn and Pegatron have shown. Foxconn, which is listed in Hong Kong as FIH Mobile, saw its revenue double last year. But its costs also soared, forcing it into the loss column, and pushing its stock to extremely low levels. Pegatron doesn't look much better, though at least that company is earning a profit.

It seems that the bottom line is probably something that all of us have known for quite sometime, namely that third-party manufacturing doesn't pay with big profits and is an extremely thin-margin business. Foxconn and parent Hon Hai have discovered this in the last few years and are trying to make a go with Hon Hai's recently purchased Sharp, the Japanese electronics brand that has fallen on hard times but still enjoys a relatively strong reputation.

Meantime, the slim big bucks out there are clearly being made by the brands that can take advantage of low manufacturing costs and big mark-ups from loyal customers. At this point Apple seems to be earning the bulk of those profits, but I expect that Huawei may be moving up the profitability chain as well. Xiaomi could be moving in that direction also, though it's still quite focused on the less-profitable low end of the market.

At the end of the day, we can probably expect to see current trends continue. That means that perhaps names like Samsung and Oppo will eventually abandon manufacturing, which they probably need to do anyhow, to focus on shoring up their increasingly shaky branded business.

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