To Woo Apple, Foxconn Bets $3.5 Billion on Sharp.

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Workers at Foxconn’s Longhua factory complex in Shenzhen, China, where it employs more than 100,000. 

HONG KONG — The Apple iPhone transformed the technology industry by popularizing the smartphone and blazing a path to a mobile future. But to do it, the American gadget company needed an important ally: a penny-pinching Taiwan-based factory operator named Foxconn.

Using vast facilities in mainland China employing hundreds of thousands of workers, Foxconn figured out a way to assemble the iPhone at a cost low enough that middle-class Americans could afford it. The business offered low profit margins, but the work buffed Foxconn’s financial results and cemented its status as the world’s largest maker of hardware for companies like Apple and Sony.

Those relationships are now shifting — and Foxconn is betting heavily to keep up.

Foxconn said on Wednesday it had struck a deal to acquire control of the Japanese screen maker Sharp for $3.5 billion, after weeks of negotiations and high-profile setbacks.

The deal, for a 66 percent stake in Sharp, is intended to make Foxconn a more attractive partner for Apple. The American technology company uses Sharp screens, which could give Foxconn added attractiveness and leverage in dealings between the two.

The Sharp purchase will saddle Foxconn with an ailing business that will take considerable money and effort to turn around, some analysts say. Reflecting those problems, the purchase price is $2 billion lower than a deal the two sides struck just last month, after Sharp disclosed the potential for costly problems — totaling nearly $3 billion in potential liabilities — down the road.

But Apple has been diversifying its supply chain, giving some production contracts to other assemblers and component makers. And Foxconn is grappling with China’s rising labor costs and a slowdown in the global smartphone market.

The deal highlights the huge pressure that the industry’s shifting dynamics are placing on Foxconn.

Night-shift workers leaving a Foxconn factory in Zhengzhou. Like China itself, the Taiwan-based Foxconn is trying to move up from basic manufacturing to higher-end businesses. 

“On the one hand, you can see why Foxconn is trying to do it. It’s not clear the economics make sense, but it’s that they need to control more and more of the supply chain,” said Willy Shih, a professor at Harvard Business School. He noted that Apple might soon switch to screens made by other producers.

The deal follows months of dramatic back-and-forth talks about the terms, including the surprise disclosure last month of billions of dollars worth of potential problems on Sharp’s books. Acknowledging Sharp’s poor performance, Terry Gou, Foxconn’s founder and chairman, said in the news release that he was “confident that we will unlock Sharp’s true potential.”

The deal is a return to form for Foxconn — formally known as Hon Hai Precision Industry — in its emphasis on scale. The company has been looking in recent years for ways to further cut costs, including investment in automation. It has also expanded into businesses potentially more lucrative than grunt-work manufacturing, opening factories producing new technology like batteries for electric cars. It even created incubators to help hardware start-ups.

Foxconn, most of whose factories are in China, is emblematic of the challenges facing the Chinese economy at large. Even while it tries to maintain the huge scale and efficiency of its production base, it is trying to climb the value chain to find new, more profitable streams of revenue.

Near Beijing, Foxconn operates a hardware incubator called Innoconn, which helps start-ups with production management while looking for investment targets.

Liu Haoyang, founder of Noitom, a company that makes motion-capture sensors and hardware, said Foxconn had approached his company when it was seeking crowdfunding for a sample product in 2014. Ultimately Foxconn gave Noitom advice, and it now helps Noitom produce, Mr. Liu said.

“They make parts of high complexity for us,” he said. “Average factories aren’t able to make this type of thing, never mind in small batches.”

Foxconn, founded in Taiwan as a maker of television knobs in 1974 by Mr. Gou, became a company with more than $100 billion in annual revenue by making things for other companies. Starting in the 1990s, as orders poured in to make personal computers, Mr. Gou built new and larger factories in China, culminating in the city-size Longhua plant in Shenzhen, near Hong Kong.

At the Longhua complex, Foxconn coordinates more than 100,000 workers assembling gadgets — including the iPhone — in daily and nightly shifts, and the feeding, clothing and planning for the turnover of workers are gargantuan challenges. The company developed recreation facilities for the campus and designed a kitchen able to churn out the huge amounts of food necessary to feed tens of thousands of workers each day.

A marvel of modern manufacturing, the Longhua plant is the most extreme example of Foxconn’s philosophy of maximizing efficiency through huge scale, though in some ways the Longhua plant has proved too large. It was there in 2010 that a series of worker suicides drew international scrutiny from workers’ rights groups and the news media. The company put nets on the sides of buildings to catch would-be jumpers. On many buildings the nets still sag today.

Foxconn’s sales growth has slowed to single-digit percentages in the past two years from the double-digit growth it posted in the past, although profit growth has picked up recently, thanks in part to consumers buying bigger, more expensive phones with bigger screens.

While Foxconn’s revenue has been padded by booming orders for less expensive Chinese-branded smartphones, increased competition from China-based suppliers has been a concern highlighted by analysts. Also, Apple has actively sought to diversify its supply chain, giving orders for iPhone assembly to Pegatron, another Taiwan-based contract manufacturer, which operates a huge factory near Shanghai.

Foxconn’s previous takeovers of screen makers have not played out well. In 2010, Foxconn took over a Taiwan screen maker, Chimei Innolux, for nearly $10 billion; analysts say the acquisition has failed to produce the efficiencies and profitability hoped for.

In Sharp, Foxconn picks up screen-making operations that have long been unprofitable and costlier than those of its rivals in China. Alberto Moel, an analyst at Sanford C. Bernstein, says that the Sharp acquisition would probably distract Foxconn from more important ventures, while also proving difficult to integrate and turn into a profitable business.

“Terry Gou is going to have to do some serious restructuring, spinouts, carve-outs, reduced head counts, centralizing things, and he’ll have to do it at a distance, across a sea with management he doesn’t really control,” Mr. Moel said. “It won’t be easy.” 
 

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