The Information Technology sector is among the broadest and most diverse in the small-cap universe. Although most typically associated with cutting edge innovations, the sector is also home to companies that supply more prosaic services such as contract manufacturing, product design and/or packaging, distribution, and other services. Many of these activities are performed by small-cap players in partnership with larger technology companies.

In one of the more interesting shifts we’ve observed over the last several years, some larger small-cap companies have been exiting, or reducing their exposure to, lower-margin, often more straightforward businesses and doing more in higher margin, more complex areas, such as electric vehicles (“EVs”), medical devices, cloud computing, and certain industrial processes or products. There are four technology holdings that we think exemplify this trend with the important added benefits of being attractively undervalued (in our view), asset light businesses. They also appear poised to benefit from secular tailwinds in areas such as EVs and healthcare as well as the reshaped post-pandemic supply chains that see companies leaving China for other locales, including the U.S.

Jabil electronics manufacturing services company that offers digital prototyping, printed electronics, device integration, circuit designing, and volume board assembly services for the automotive, consumer health, data centers, energy, and defense and aerospace sectors worldwide. It currently has a partnership with Amazon as well as relationships with Apple, Tesla, other EV makers, and Johnson & Johnson. Jabil is in talks to sell its China-based manufacturing business for $2.2 billion, which reduces its customer concentration risk with Apple, while bringing in ample cash that Jabil plans to use to boost its EV and medical device businesses. With clouds recently looming over consumer electronics sales that have somewhat crimped share price performance, Jabil’s valuation looks highly attractive to us. The market seems to not fully appreciate the long-term benefits of the company’s lowered exposure to consumer electronics and consequent greater penetration into higher-margin areas such as EVs, cloud computing, and medical devices.

Flex is also an electronics manufacturing services company, with a focus on designing and developing original design manufacturing (ODM) products. It offers technology innovation, supply chain, and manufacturing solutions to a diverse group of industries and end markets. Like Jabil, it has entered more complex—and potentially profitable—activities while shedding less profitable businesses. In the case of Flex, it sold part of its interest in NEXTracker, which provides solar tracker and software solutions for utility-scale and ground-mounted distributed generation solar energy projects, to a private equity firm before taking it public in February 2023, though Flex still owns half of the shares. It will likely sell or spin off the remainder to shareholders. A sale would yield significant cash and thus help finance capital spending in the U.S. to help further its activities in higher-margin areas—which include cloud infrastructure, EV charging stations, medical devices and equipment, and specialized industrial devices. In our view, its recent valuation indicates that other investors look at Flex solely as an electronics manufacturing company and are missing how effectively the company is adding other areas of expertise in high-demand—and high-margin—industries in areas undergoing positive secular shifts.

Two other electronics contract manufacturers that we think are similarly undervalued and well positioned for long-term success are Sanmina Corporation, which is expanding its portfolio of activities into low volume, high margin areas within the communications and aerospace & defense industries, and Kimball Electronics, which has a well-established niche in areas of automotive manufacturing such as power steering components and regenerative braking that will remain in demand amid the transition to hybrid and EVs.

What each of these companies is doing can be distilled into a change in business mix that we think will result in lasting positive changes in profit margins. They are also useful examples of the breadth within Information Technology and the appeal such businesses have for risk-conscious value investors with a long-term perspective.

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