Why a Hon Hai, Quanta merger likely won’t happen

Rumors of a tie-up between the world’s largest desktop PC manufacturer and the biggest notebook maker resurfaced again after the resignation of a key executive at Quanta Computer Inc., but analysts said such a union could threaten major vendors such as Hewlett-Packard Co. and Dell Inc., and that the big U.S. companies have the power to stop such a deal.

The president of laptop maker Quanta Computer, Michael Wang, resigned Aug. 24 after months of speculation he planned to leave the company. In a farewell letter to employees, the popular executive raised the issue that “it is better to have Hon Hai as an ally than an enemy,” reigniting market speculation of a possible merger (M&A) with Hon Hai Precision Industry Co. Ltd.

While a merger could create a company able to drive down costs by wrangling volume discounts out of component suppliers, it would also be the world’s largest maker of desktop and laptop computers. The concentration of so much manufacturing power into one company could threaten major PC vendors in several ways, including the prospect that the company could drive competitors out of business and then raise prices, analysts said.

That’s why PC vendors, including Acer Inc. and Lenovo Group Ltd., would likely move to block such a tie-up, and they can do so by giving and taking away lucrative orders, said Vincent Chen, PC industry analyst at CLSA Emerging Markets in Taipei.

Major PC vendors have several choices when placing orders for new desktops, laptops and other gadgets, and have used this leverage to squeeze out rock-bottom prices for assembly. Quanta’s gross margin, an indication of how profitable a company is, was just 4.1 percent in the second quarter, compared to 19.9 percent for Dell and 14.9 percent for Lenovo, in their most recent quarters.

“There are too many other contract manufacturers for them to choose from,” said Daniel Chang, PC industry analyst at Macquarie Equity Research in Taipei. PC vendors diversify their risk and keep prices down by farming out production to several contract manufacturers, and they would punish Hon Hai if it bought Quanta by shifting orders away, he said.

Dell and HP could not be reached for comment, while Lenovo was unable to immediately reply and Acer declined to comment.

Hon Hai and Quanta have denied the M&A rumors numerous times publicly, including in a few strongly worded statements.

In six statements filed to the Taiwan Stock Exchange, Hon Hai has denied any inkling of talks to merge with or take over Quanta. Its most colorful statement, from July 10, said it “vehemently refutes and ridicules for the fourth time the unfounded market rumors on a Hon Hai-Quanta merger,” while its most recent statement, dated Aug. 28, is shorter, simply denying a local newspaper report speculating on a deal.

Quanta has made similar denials. At a news conference last Friday, Vice Chairman C.C. Leung said there is no M&A plan with Hon Hai. Quanta plans to continue to improve its relationship with Hon Hai in the future, just as it does with all of its suppliers and customers, he added.

Hon Hai is the world’s largest contract electronics manufacturer, assembling goods ranging from Apple Inc. iPods to Nintendo Co. Ltd. Wii game consoles and Nokia Corp. mobile phones. The company and its affiliates, including Foxconn International Holdings Ltd., manufacture more PCs, mobile phones and networking gear by contract than any other company.

Speculation that Hon Hai might buy Quanta cropped up in part because the laptop segment is the only major electronics area Hon Hai isn’t involved in directly, and could provide a major new growth driver for the company. Chang reckons Hon Hai will likely start manufacturing laptop computers within the next few years, but likely won’t buy out another major rival to do so.