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Introduction

The history of the memory industry has been marked by dramatic technological changes, extreme peaks and troughs, government bailouts, numerous acquisitions as well as bankruptcies. Semiconductor companies in the memory segment have invested billions of dollars each year to sharply decrease costs and prices. However, this has not translated into sustained profits as the industry is plagued with periodic overcapacity. This leads to a sharp fall in unit prices, which in turn results in heavy losses for the companies. Due to capital intensive nature of the business, even top memory companies such as Samsung (OTC:SSNLF) have never managed to run a profitable business on a sustained basis.

However, we think that the scenario for the memory industry may be changing, as only four big players are left in the DRAM and NAND markets. In DRAM, two of the heavy hitters are Koreans (Samsung, Hynix (OTC:HXSCF)) while the other one is American (Micron (NASDAQ:MU)). In NAND, the market is dominated by Toshiba (OTCPK:TOSBF), Samsung and Micron. Note the number of companies in the memory industry has continued to decline since the 1990s, with the exit of Intel (NASDAQ:INTC), Texas Instruments (NASDAQ:TXN) and most of the Japanese conglomerates. The last 3-4 years have been even more brutal for the industry, with the bankruptcy/ takeover of some of the biggest remaining players like Spansion (NYSE:CODE), Qimonda and Elpida (OTC:ELPDF).

What we like about Micron Technology

  1. Industry Consolidation - The memory industry has reached a critical level of consolidation, with only four key players dominating the memory market. Toshiba and Hynix are strong in NAND and DRAM, respectively, but they don't have a big presence in the entire memory market like Micron and Samsung. With the number of players diminishing, it looks unlikely that the industry will suffer from the same cycles of extreme peaks and troughs as seen in the past. While one could argue that you might see Intel-like dominance in the memory market by Samsung, we don't consider this case likely.

  2. Strategic Importance - Micron is the only major Western memory company left, with the rest of the memory companies being all Asian. Qimonda, which was the only other big memory player left, announced bankruptcy a couple of years ago.

  3. Memory Market seems to have formed a bottom - After a tough last two years, the memory market seems to be forming a bottom, with DRAM prices expected to rise next year. While Windows 8 has not led a strong PC upgrade cycle yet, the advent of ultrabooks and PC-tablet convertibles might spark a surge in PC sales next year. As PCs form the biggest market for DRAM memory, we might see a surge in demand in 2013.

  4. Presence across Memory Segments - Micron has a major presence across memory segments such as NAND, DRAM and NOR areas. The company is also investing resources into newer memory areas, like Phase Change Memory (PCM). The company has a big presence in both DRAM and NAND memory segments and can switch capacity to meet higher demand in either of these two areas.

  5. Benefits from Elpida acquisition - Micron is in the process of acquiring the 3rd largest DRAM player Elpida, which will make Micron the 2nd largest DRAM company. The company has offered to pay $750 million in cash and $1.75 billion in annual installments to buy Elpida. This Japanese company was suffering from high debt and had exhausted all other options to fund itself. The company had been surviving due to the support from the Japanese government and banks. However, the company was not able to navigate the brutal downturn in the DRAM industry and had to sell itself. Micron will not only get valuable manufacturing assets through this acquisition, but also valuable technology. The company has also got a foothold in the consumer mobile space with Apple as a customer.

  6. Potential Beneficiary of the Apple (NASDAQ:AAPL) - Samsung rivalry - Apple has an awkward relationship with Samsung, being its biggest competitor as well as one of its biggest customers. Apple is already trying to shift its application process business from Samsung to TSMC (NYSE:TSM). The company may also try to change its memory supplier in the future. In DRAM, Micron remains the only other alternative. Even in NAND, Micron remains the only non-Samsung supplier apart from Toshiba.

  7. NAND prices going up and increasing SSD adoption - Micron is a major NAND memory producer and will benefit from the increasing adoption of Solid State Drives (SSD) in consumer devices. The increasing demand for tablets and smartphones is boosting the demand for NAND memory. The prices for NAND are already up in Q412. MU can also convert its DRAM fabs into NAND ones, if the demand escalates. Micron is also working on becoming a SSD producer by making its own SSD controller.

Risks

  • Stock Performance - Micron has climbed by almost 40% in the past few months, after it won approval to buy Elpida. The company has climbed from $5.5 to $7.8, as investors realize the benefits of the Elpida acquisition. However, the stock is still 15% below its peak of $9.16, reached in the beginning of 2012.

  • Losses in the last few quarters - Micron has shown losses in the past 5 quarters, reporting ~$200-300 million in losses every quarter, with ~$2 billion in average revenues. The company shows periodic profits and losses like the rest of the industry. In FY 12, the company reported ~$1 billion in losses after making a profit of $1.9 billion in FY 10. We don't think the losses in the past few quarters are a big negative, as the memory industry is a cyclical one. The company does not have too much leverage unlike some other memory companies, with total cash of ~$2.5 billion and total debt at ~$3.3 billion.

Valuation

Micron is not expensive with a P/S and P/B ratio of 1x and 1.1x, respectively, though the company seems expensive on a forward P/E basis at 31x. However, this is due to the cyclical nature of the memory industry. I don't think it is meaningful to compare Micron with other semiconductor companies because of substantial differences. Also, there are almost no pure play memory companies to compare Micron with. We think Micron has the potential to substantially expand its multiples, as the memory industry changes its character from a cyclical industry.

Summary

We think that Micron is set to benefit from a consolidation of the memory industry, which will reduce the cyclical nature of the industry. Micron is the only company apart from Samsung which has a market leading position in both DRAM and NAND memory segments. Micron has managed to acquire Elpida for a cheap price and will generate substantial merger benefits from 2013 onwards. Micron also has a strong presence in new upcoming memory areas like Phase Change Memory. The Apple-Samsung rivalry could also prove to be a boon for Micron, as Apple might move its NAND and DRAM orders to Micron. We see little risk in buying Micron here and would add the stock on dips.

Source: Micron Technology - And Then There Were 4