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Hon Hai's Apple pie under threat from Pegatron

By Clare Jim

TAIPEI (Reuters) - Hon Hai Precision Industry Co Ltd <2317.TW>, the world's largest electronics contract manufacturer, faces growing competition from cross-town rival Pegatron Corp <4938.TW>, a company that is just a quarter of its size by revenue.

Hon Hai, better known by its trading name Foxconn, draws an estimated 60 to 70 percent of its revenue from assembling gadgets and other work for Apple Inc . But it has been struggling to grow in a smartphone market increasingly dominated by Samsung Electronics Co Ltd <005930.KS>.

Fellow Taiwanese manufacturer Pegatron wants to grab more orders to assemble the fast-selling iPhone and iPad from the California-based tech giant. Analysts say Pegatron offers more competitive pricing - at the expense of lower margins - and appears to be succeeding in pulling in more orders from Apple.

Pegatron's announcement last week that it would increase its number of workers in China by up to 40 percent in the second half of the year fuelled market speculation that it would be the sole assembler for a widely expected cheaper iPhone.

"Pegatron posts a long-term risk to Hon Hai because as it catches up on margins by supplying more components, it can provide more aggressive pricing," Daiwa Capital analyst Birdy Lu said. "Hon Hai's margin uptrend is not a guarantee."

Hon Hai is expected to post a net profit of T$18.76 billion ($638.24 million) in the first quarter, according to 13 analysts polled by Thomson Reuters I/B/E/S. Results are due to be released early this week.

This would be 26 percent higher than a net profit of T$14.92 billion in the same period a year earlier, before the company adopted a new accounting standard, but only around half of the record T$36.97 billion in the previous quarter.

The company, which has come under fire for labor conditions in its factories supplying Apple, has raised wages and improved amenities. But rising labor costs erode margins, and it has been moving manufacturing to China's cheaper inland provinces.

MARGINS NARROW

Apple, along with its suppliers, relies heavily on new product launches to drive revenue growth. Apple's Chief Executive Tim Cook told analysts last month that "some really great stuff" would come in late 2013 and 2014, suggesting it would be a few more months before the company has any new products.

Samsung, by contrast, recently launched its newest Galaxy S4 smartphone to strong demand. Samsung relies on its own in-house supplies for the majority of components in its smartphones.

Apple posted its first quarterly profit decline in more than a decade in the March quarter, and forecast revenue of $33.5 billion to $35.5 billion this quarter, compared with $43.6 billion in the previous quarter.

Despite rising profit, Hon Hai recorded a revenue slide of 19.2 percent in the January-March period.

Pegatron's revenue grew 29 percent in the same period from a year ago, while its net profit surged 81 percent to T$2.31 billion ($78.59 million).

Pegatron currently makes older models for Apple, including the iPhone 4S and iPhone 4, It also manufactures the iPad mini.

"Hon Hai would see a flat revenue this year at best... while Pegatron has great growth potentials because it is going from nothing to something," said HSBC analyst Jenny Lai. "But Hon Hai's margins would improve, benefitting from getting more component orders.

Foxconn Technology Group, Hon Hai's holding company, has been trying to turn itself into a high-margin purveyor of sophisticated components to escape from the ever decreasing margins in its traditional business.

"I think it'd be a misconception to label Foxconn as just an assembly line manufacturer," group spokesman Louis Woo told Reuters late last year in an interview. "From glass to cable connectors, we're playing a critical part in components."

In the fourth quarter, Hon Hai's operating margin climbed 3 basis points to 3.7 percent, compared with the previous three months, while Pegatron's operating margin improved by 2 basis points to 0.3 percent. In the March quarter, Pegatron's operating margin increased by 5 basis points to 0.8 percent.

"Pegatron's margins are still a lot lower than Hon Hai's. This is because Pegatron's offering very competitive pricing and that's how it wins orders," said Lai.

($1 = 29.3935 Taiwan dollars)

(Reporting by Clare Jim; Editing by Emily Kaiser)

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