Plexus Strikes Deal with Kontron

Plexus Corp. (PLXS - Analyst Report) recently announced an asset-based transaction with Germany-based Kontron AG, a leading provider of embedded computer technology. Under the terms of the agreement, Plexus will buy certain assets of Kontron Design Manufacturing Services (KDMS), a wholly owned subsidiary of Kontron AG, in Penang, Malaysia, for approximately $30.0 - $35.0 million.

Kontron will shift all manufacturing units of KDMS to Plexus’ Penang facilities. In exchange, Kontron is expected to contribute approximately $100.0 million of incremental revenue annually for two years. The transaction is expected to be completed by the next few weeks.

The transaction will further expand Plexus’ operations in the low-cost regions of the Asia-Pacific. However, we believe that the transaction will be much more beneficial for Kontron in the near term, as it will allow the German company to focus on its core business. The transaction is also expected to boost Kontron’s working capital and earnings per share for 2012.

Plexus expects the transaction to be beneficial over the long term. The transaction is expected to add incremental revenues of $50 - $75 million for Plexus based on specified volumes from Kontron, and is expected to be modestly accretive to its earnings in 2012. However, Kontron’s significant exposure to Europe will be a concern for Plexus going forward.

We believe that engineering agreements generate higher margins and are generally incremental to the company’s overall profitability. We believe that the manufacturing agreement will boost Plexus’s growth in the industrial/commercial sector. In fiscal 2011, the industrial/commercial sector was the second largest contributor to Plexus’s top-line growth. We believe that the agreement with Kontron will boost Plexus’s top-line and bottom-line growth going forward.

Plexus has also been expanding its footprint in low cost regions and has already established its presence in Mexico, the U.K., Malaysia and China. In fiscal 2011, Plexus commenced construction in Xiamen, China, which is expected to be completed during the second half of fiscal 2012. The company also began construction of an additional manufacturing facility in Penang, Malaysia during early fiscal 2011 and anticipates completing the facility in the first quarter of fiscal 2012.

During the first half of fiscal 2012, Plexus anticipates announcing the construction of a larger facility in Oradea, Romania to replace the leased buildings. Plexus plans a total area of approximately 3.5 million square feet in 2014 compared with 2.8 million square feet in 2011. We believe that increasing capacity will boost margins over the long term.

Plexus narrowed down its first quarter guidance and now expects revenue in the range of $525.0-$530.0 million (earlier guidance was $510.0 million to $540.0 million) based on approximately $200.0 million worth of new program wins. Earnings per share are now expected in the range of 48 cents to 50 cents (earlier guidance was 44 cents to 49 cents).

We maintain our Underperform recommendation on Plexus over the long term. The company continues to face cut-throat competition in the EMS market from Flextronics Inc. (FLEX - Snapshot Report), where component shortages and supply chain constraints are increasing operational complexities. Moreover, Plexus continues to invest in new sites and increasing headcount that may affect profitability in the near term.

Currently, Plexus has a Zacks #3 Rank, which implies a Hold rating in the near term.