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Micron Technology (NASDAQ:MU) is poised to become the world's second-largest DRAM chip maker with the acquisition of Elpida. This acquisition will boost the DRAM (Dynamic Random Access Memory) chips portfolio of Micron. Micron focuses on PC DRAM while Elpida is mostly focused on DRAM for tablets and phones. Therefore, a combination of the two would provide good synergy to Micron, enabling it to work in either market. Also, it has gotten itself a highly interesting deal, as you will just see.

The stock is currently up 40% compared to last year. It is expected to rise further as the acquisition of Elpida is completed. Micron manufactures and provides NAND flash, DRAM and NOR flash memory solutions. Let us look into the deal to know about the synergies acquired by Micron from this acquisition.

Specifications Of The Deal

Elpida is a DRAM chip maker based in Japan. The fall in the memory chips sales and increasing foreign competition has forced Elpida into bankruptcy. The acquisition of Elpida is a good buy for Micron in terms of the finances involved. Micron is buying Elpida for $2.5 billion but there is a catch in the deal. According to the sponsor agreement between Micron and Elpida, Micron will pay initially only $750 million in cash in exchange of 100% ownership of Elpida. The remaining amount of $1.75 billion is to be paid in interest free annual installments through 2019. But, the remaining amount of $1.75 billion will be paid from the operational cash flows generated by Elpida. So, in case Elpida is unable to generate positive operational cash flows then Micron is not liable to make payments. In this way, Micron has successfully hedged its payments to Elpida's creditors in the event of future bad performance of Elpida. In terms of the costs involved it is a really good buy for Micron.

I am intrigued by the specifics of this deal. Micron probably has to show only $750 million as expenses for its acquisition of Elpida in the next quarterly earnings report and the balance sheet of 2013. This should not have as large a impact on the net earnings as compared to the whole amount of $2.5 billion. The deal involves conditional annual payments to the creditors, and there is also the possibility of a scenario in which Micron gets the whole deal for only $750 million in case of bad operating performance by Elpida.

What Micron Will Gain From This Deal

Currently, Micron's NAND chips business is its largest business segment. In 2012, it NAND business contributed 35% to Micron's total revenues. Micron's DRAM business contributed 33% to the total revenues. The DRAM industry is basically divided into the PC DRAM market, and the DRAM market for mobile phones and tablets. Micron's major focus is on the PC DRAM market and enterprise DRAM solutions for networking and servers. Elpida provides DRAM solutions to mobile phones and tablets. Therefore, the acquisition of Elpida will strengthen the DRAM product portfolio of Micron. The acquisition will increase the total wafer capacity of Micron by 45% from the existing capacity of 300 million.

Acquisition of Rexchip

Micron has also acquired Powerchip Technology's stake in Rexchip Electronics. Micron has acquired Powerchip's 24% stake in Rexchip for approximately $334 million.

These acquisitions will make Micron the second-largest supplier of DRAM chips globally, only behind Samsung Electronics (OTC:SSNLF). With the acquisition, Micron will leave behind SK Hynix, a South Korean company, to become the world's second-largest DRAM chip maker by revenue.

The acquisitions will increase Micron's production capacity of DRAM from existing 160,000 wafer starts per month to 370,000 wafer starts per month in the long term. Thus it will enable Micron to overtake SK Hynix, which currently has the production capacity of 300,000 wafer starts per month.

Currently, Samsung Electronics is the market leader with 40.8% market share in the DRAM market. Hynix has 24.2% market share. The acquisitions will increase the market share of Micron to 24.8% making it the second-largest player in the DRAM market.

The acquisition of Elpida will help Micron in achieving greater economies of scale.

Consolidation In The DRAM Industry

The DRAM industry has witnessed a fall in revenues since the supply factor has exceeded the demand. Until recently, the market was crowded by seven players, which led to increase in supply, competition and reduction in prices. This resulted in decrease in the revenue. But, now consolidation has taken place in the industry. There are now three major suppliers in the market - Samsung, Micron and Hynix. Thus the supply base has reduced in the DRAM market. The consolidation in the DRAM market led by acquisitions will reduce the supply and demand gap and will help in increasing revenues due to higher pricing of the DRAM products.

Micron's Financials and Stock Analysis

According to the results of Micron for Q2 2013, the DRAM revenue has increased 24% as compared to Q1 2013. This increase is mainly due to an increase of 38% in the volume of the DRAM products sold.

The stock is currently trading at the price of $9.42 and it is about 40% up from the low level of $5.6, which the stock touched in November 2012. The stock is expected to rise further with the completion of the acquisition.

Competitor

SanDisk (NASDAQ:SNDK) offers NAND and data storage solutions. SanDisk is expected to grow its revenues with growth in the future demand for Solid State Devices (SSD). The market for enterprise SSDs is expected to grow 59% annually until 2016 with the increase from 382,000 units in 2011, to 3.9 million units in 2016. This will increase the SSD revenues from $582 million in 2011, to $3.5 billion in 2016. SanDisk can face stiff competition from Micron in the NAND business. Micron's SSD revenue has increased by 33% in Q2 2013.

SanDisk is also present in the external storage devices market. With the increase in the penetration of smartphones and other digital devices, the demand for external memory cards has increased. This translates into a good opportunity for SanDisk to increase its revenue in the external storage devices segment.

Conclusion

With the change in the dynamics of the DRAM industry, Micron is poised to grow its revenue and strengthen its position. Micron is a buy for the long term. With the acquisition of Elpida, Micron will witness growth in its DRAM revenues. Micron's NAND business is expected to repeat the successful performance as shown in the last quarter. Thus, the future business outlook for Micron is positive.

Source: This Chip Maker Is A Buy