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Abu Dhabi, UAETuesday 25 September 2018

Apple maker Hon Hai shows nifty grasp of tricks

Taipei-based firm gets about half its revenue from Apple yet it also makes a lot of money from activities that don't involve thousands of people working on a factory floor

A motorcyclist rides past the logo of Foxconn, the trading name of Hon Hai Precision Industry, in Taipei, Taiwan. The company makes significant money from non-manufacturing activities. Tyrone Siu/Reuters
A motorcyclist rides past the logo of Foxconn, the trading name of Hon Hai Precision Industry, in Taipei, Taiwan. The company makes significant money from non-manufacturing activities. Tyrone Siu/Reuters

In operation for more than 40 years, this outfit has grown to $106 billion in assets with investments in more than a dozen countries - most of that is in China.

Its returns probably wouldn't have you popping the corks - 12.8 per cent last year on a return-on-equity basis, 4.6 per cent if you're looking at return on assets. But it has never posted a loss, so that's something. Its founder and chief executive officer is a 67-year-old billionaire while its CFO is a low-key long-termer affectionately known as "Money Mama".

Oh, and it also makes iPhones for Apple, PlayStations for Sony and routers for Cisco Systems.

Hon Hai Precision Industry isn't technically a hedge fund. But, you know, if it looks like a duck and quacks like a duck. And it does a lot of quacking: at the end of 2016 the flagship of Terry Gou's Foxconn Technology Group held more than $20bn of hedging instruments in the form of swaps and forwards contracts.

And lest you think hedge funds are only about shorting stocks or trading commodities, it's worth noting that Connecticut-based Bridgewater Associates, the world's largest at around $160bn in assets, has dabbled in such humdrum investments as equity ETFs.

Taipei-based Hon Hai gets about half its revenue from Apple. Yet it also makes a lot of money from activities that don't involve thousands of people working on a factory floor. In fact, profits on manufacturing are pretty thin and getting thinner. The markup last year - measured as gross margin - fell to 6.44 per cent.

And even that profit isn't just from product assembly. A large portion of the $138bn of cost of goods sold that it posted for 2017 was actually purchased by or on behalf of clients.

Foxconn gets to channel its customers' component procurement through its own books - helping it prop up the top line while taking a cut as it flows through to the bottom line. That's not money from making iPhones but from playing the margins.

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Consider operating costs, and the margin drops to 2.4 per cent. So the company made just $3.5bn last year from operations, with the amount coming purely from product assembly being substantially lower. By comparison, its non-operating profit was $2.2bn.

To understand the financial engineering that goes on at Hon Hai, it's helpful to examine the dozens of filings the listed entity posted to the Taiwan Stock Exchange last year; they show it's extremely busy investing in financial products. One such statement, in January 2017, says it spun a 500 million yuan (Dh290.1m) short-term investment into a 2.88 per cent annualised return. Remember that its operating margin was 2.39 per cent.

A spate of filings in the fourth quarter put Hon Hai on track to post almost NT$7 billion (Dh881.6m) in disposal gains, equal to 21 per cent of its operating profit for the period. Then came the Big Kahuna.

By offloading Class C shares in Sharp to its own employees, Hon Hai booked a ¥252bn profit (Dh8.81bn). A Cayman Island company called ES Platform, supposedly owned by Hon Hai staff members, somehow managed to rustle up $3.3bn to buy those shares at a very healthy profit to their employer. Hon Hai says the money has gone through but wouldn't say where the cash came from.

Travis Lundy of Ballingal Investment Advisors said this week that one explanation could be that Mr Gou himself is backstopping the deal. I suspect he may be right, which would mean he may have also fronted for that giant one-off profit boost at Hon Hai right at the end of what was looking to be a disastrous year for the company.

True to hedge-fund form, not all bets pay off. It's burning money on the revival of the Nokia brand name, while a stab at the India e-commerce market ended with its majority-controlled subsidiary FIH Mobile losing $200m.

Mr Gou needs to wean himself off being Tim Cook's manufacturing partner. He's no Ray Dalio, but Foxconn's financials show that he does, in fact, know a few more tricks.

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