Minnesota firms pivot in face of Thai floods

  • Article by: STEVE ALEXANDER , Star Tribune
  • Updated: February 4, 2012 - 8:58 PM

Production of the world’s disk drives was dramatically disrupted — and local companies have had to adjust.

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Digi International supply firm moving circuit boards from the flooded plant to a different one. PHoto credit:

Last year's flooding in Thailand was a mammoth natural disaster. And now, because a vital segment of the electronics industry clustered in a Thai flood zone more than two decades ago, the Twin Cities and many parts of the world are feeling the economic pain of that country's worst flooding in 50 years.

Beginning last July and extending well into the fall, flooding caused an estimated $45 billion in damage and left nearly 400 dead. About 14,000 Thai factories were closed, putting 660,000 people out of work.

And more than 40 percent of the world's disk-drive manufacturing was suddenly under water.

Thailand has become the manufacturing hub of the disk-drive industry. Hundreds of technology companies and their suppliers had crowded into low-lying Thai industrial parks because it was cheaper and faster to move electronic parts across town than around the world.

But Thailand doesn't look like such a bargain now. The Star Tribune sifted through public statements of Minnesota public companies and found the Thai flood had affected at least five firms that are either based in the state or have extensive operations here. Hutchinson Technology, Seagate Technology, 3M, Donaldson Co. and Digi International are dealing with shortages of electronic parts, though none of their workers was killed or injured in the flooding.

Consumers are already seeing the impact play out, as the price for disk drives used in personal computers has risen 20 to 50 percent. Shortages could persist for months. What's more, personal computer makers Apple, Dell and Hewlett-Packard have warned that shortfalls in disk-drive production will hamper their ability to produce enough desktop, laptops and notebook computers to meet demand.

For disk-drive-component maker Hutchinson Technology, based in Hutchinson, Minn., the Thai flood was a tough blow. Already in dire condition after financial losses and layoffs, Hutchinson now faces $25 million to $35 million in costs to rebuild its inundated plant in the Rojana Industrial Park in Ayutthaya, Thailand, and to pay for substitute operations in the United States.

Its Thai factory, which opened in 2010 and was Hutchinson's only foreign plant, accounted for one-third of Hutchinson's revenue. But it's been closed since the second week of October, when employees could be seen standing in shoulder-deep water in front of the building.

The only bright spot is that 120 U.S. manufacturing workers who were to have been laid off have had their jobs saved by Hutchinson. They are needed to build up the company's U.S. manufacturing, so it can partly make up for the closed Thai plant. "There are no more layoffs planned," the company said.

Hutchinson disclosed the damage in its government filings because of the potential impact on its finances. The company was willing to provide only a little additional information, saying last week that the crisis was past and recovery was underway.

The company also cited its pending capital markets transaction, saying that "because this is an ongoing process, we are not in a position to have our employees speaking with the media about the company's operations."

Seagate benefits

The same shortage of disk-drive production that plagues Hutchinson will force consumers to pay more for a disk drive or a personal computer containing a drive. That in turn will affect PC sales. Because too few disk drives are available, shipments of personal computers are expected to fall nearly 4 million units short of demand in the first quarter, said California research firm IHS iSuppli. The biggest shortage will be in notebook PCs.

But the bad news for Hutchinson Technology and consumers has turned out to be good news for California-based Seagate Technology, which manufactures disk drives in the Twin Cities. Analysts say the disaster has indirectly benefited the company, which avoided flood damage while reaping higher profits because of the resulting disk-drive shortage.

"Seagate has plants in Thailand that are on higher ground and weren't affected by flooding," said Mark Miller, an analyst at Noble Financial Capital Markets in Boca Raton, Fla. "So in some ways this is a windfall for them. Due to parts shortages, their disk-drive production is down 10 percent, but the price of the drives they do make went up 20 percent. And over the last 90 days, 2012 earnings estimates for Seagate have tripled."

At a Morgan Stanley investment conference in November, Seagate Chief Financial Officer Patrick O'Malley agreed that the company had not sustained any flooding damage itself, but said its supply chain had taken a beating. Seagate officials didn't respond to a request for comment.

This episode raises the question: Should the disk-drive industry be clustered in Thailand -- or in any single location?

"This is the biggest natural disaster disruption ... since at least the 1980s," Miller said. "But the disk-drive industry is driven by costs, so it's better for the manufacturers and suppliers to be close to each other than to be in different places."

'Material and significant'

David Vang, a professor of finance at the University of St. Thomas in St. Paul, said publicly held companies such as Hutchinson must disclose in government filings any events that are "material and significant," meaning they can be measured and are likely to affect company earnings by 5 percent or more. If the news is bad, companies have little incentive to disclose more details than they are legally required to by the federal Securities and Exchange Commission, Vang said.

Hutchinson's Thailand plant repair cost doesn't include the value of sales that have been lost as a result of flood's ripple effects. Hutchinson's customers, the disk-drive manufacturers, can't get enough Thai-manufactured parts to make the usual number of disk drives.

As a result, they need less of Hutchinson's product, a "suspension assembly" that holds a reading and writing chip above a rapidly spinning disk. Hutchinson hasn't disclosed the income it lost due to lower revenue, said spokeswoman Connie Pautz.

While the waters have receded, the Thai flood has delayed for months Hutchinson's plans for financial recovery. CEO Wayne Fortun told analysts on a recent conference call that, while the Thailand plant is expected to resume operations by the end of June, "it will take until the middle of fiscal 2013 to return to the pre-flood outlook level."

'Rethinking' Thai facility

While Hutchinson says it believes pressure from the technology companies will force the Thai government to exercise proper flood control, it's also considering other options.

"We are rethinking our Thai facility, which we were going to expand on that site," Fortun said on the conference call. "We're not going to do that now. We'll pick another site on higher ground, in Thailand or Malaysia or maybe somewhere else, so that we don't have too much production on any one single site."

Others suffered less from the flood. 3M said last week in connection with its fourth-quarter earnings report that the flooding of its Thailand plant reduced the company's quarterly revenue by about $35 million and cut operating profit by $20 million. It declined to disclose which product was involved, but said it was sold to the auto and electronics industries.

Donaldson Co. of Bloomington was hit by the flood's ripple effects. The company makes air-filtration systems, including tiny air filters that keep dust and moisture out of disk drives. Without the filters, tiny foreign particles can cause a read-write chip to crash into the rapidly spinning disk that is only a tiny fraction of an inch away, said Rich Sheffer, Donaldson Co.'s assistant treasurer. While the firm typically generates about 5 percent of its annual sales from the disk-drive industry, that number is down because fewer disk drives are being manufactured now as a result of the Thai flood.

Some affected companies were fortunate because they weren't in the disk-drive business.

Digi International of Minnetonka, a maker of wireless and wired communications devices, was hurt when one of its independent suppliers of computer circuit boards was flooded. The Thai flood depressed Digi's first-quarter earnings by about 5 cents a share and lowered revenue by about $3 million, the company said in government filings.

But Digi was able to shift to other suppliers around the world because circuit-board production is not clustered in Thailand the way disk-drive manufacturing is.

"Our strategy all along has been geographic dispersion of suppliers," said Steve Snyder, Digi's chief financial officer.

Some think the Thai flood may result in the breakup of vulnerable industry clusters like the disk-drive enclave in Thailand.

"People are learning that there is a balance to be struck" between more expensive domestic manufacturing and less-costly overseas production, said Peter Hammond, president of Chaska-based AsiaSource, which helps small U.S. companies decide how to do business in Asia.

"Thailand has reemphasized something that everybody should have known: Don't put all your eggs in one basket."

Star Tribune research reporter Patrick Kennedy contributed to this report. Steve Alexander • 612-673-4553

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