Most of the analysts have apparently not figured out what this really means. This is apparent by the range of opinion from sell to pounding-the-table buy ratings on Micron. Analysts using standard tools of Price-to-Book, Debt-to-Equity and ignoring cash flows will find this remarkable deal difficult to analyze.
I asked Seeking Alpha member and commenter RJackson29 to help with the numbers here, since he has deep background in the semiconductor business and finance. His estimates for Micron earnings for the past two quarters have been within $.02, far better than any analyst.
Much of what will be discussed here is published in a Micron form 8-K filed on February 5, 2013 in connection with a debt offering.
Elpida filed for bankruptcy protection on February 27, 2012, the victim of brutal price declines in DRAM memory. Several companies expressed interest and entered bids to acquire Elpida. Some of the companies involved were Toshiba, SK Hynix, TPG and Micron. By May 4, 2012 all bidders had withdrawn except Micron. On July 2, 2012, Micron and Elpida signed sponsor agreement to allow Micron to acquire Elpida. To get a flavor for the negative attitude toward the memory business at this time, the SK Hynix stock priced surged on the news of their withdrawal from the bidding process for Elpida.
Micron agreed to pay 200 billion yen ($2.44 Billion) for Elpida and to be responsible for some "bridge" financing to allow Elpida to continue operating until the closing of the deal. On closing, Micron was to pay 60 billion yen ($731 million) to Elpida for transfer to Elpida creditors. The balance of the 140 billion yen is to be paid OUT OF ELPIDA EARNINGS in six annual, interest free, payments to Elpida creditors. In a simultaneous agreement, Micron agreed to pay Power Semiconductor of Taiwan $344 million for the 24% of Rexchip not owned by Elpida.
So, the total cash outlay by Micron upon closing was to be $731 million to Elpida and $344 million to Power Semiconductor, for a total of 1.075 Billion.
In the Form 8-K filed on July 31, 2013, related to the closing of the acquisition, due to the recent decline in the value of the yen, the actual amounts paid were $612 million to Elpida and, due to a minor decline in the Taiwanese currency, $334 million to Power Chip Semiconductor for a total cash outlay of $946 million. Micron has no obligation for further payments to Elpida creditors.
In summary, this acquisition was negotiated in the worst-ever market for memory, when Elpida was just a few steps away from not just bankruptcy, but liquidation. At the time this was not viewed as a sweet deal, it was more accurately described as an insanely risky Micron purchase of production assets at pennies on the dollar of replacement value.
What has happened since May of 2012?
With the withdrawal of Hynix on May 4, 2012, it became known that Micron was the only bidder left in a position to complete the acquisition of Elpida. On May 17, 2012 Apple (AAPL) loaded Elpida to the roof with mobile DRAM orders, making Elpida short term profitable. PC DRAM prices bottomed on December 3, 2012 and have been increasing ever since. The spot price for commodity 2Gb DRAM on that day was $.82. Today the spot price for that part is $1.62, nearly a 100% increase. As though that isn't enough good news, the value of the yen has declined 20%, reducing the dollar cost of the Elpida acquisition since the deal was denominated in yen. Not all of this reduced cost will be realized because Micron entered into some hedges against an increase in the value of the yen, but the currency difference made a $120 favorable difference in the initial payment. It will also result in a reversal of about $214 million in mark to market losses already booked by Micron.
What did Micron get in this transaction?
Micron is accounting for this acquisition under FASB ACS 805, which means assets are marked-to-fair valuation, which means Micron just acquired Elpida probably for less than its cash, receivables and inventory. The pro forma financials in the form 8-K referenced at the beginning of this piece reveals:
(All tabular amounts in millions except per share amounts)
The estimated consideration and provisional valuation of assets to be acquired and liabilities to be assumed are as follows:
Cash paid at closing
Assets acquired, liabilities assumed and noncontrolling interests:
Cash and equivalents
Other current assets
Long-term marketable investments
Property, plant and equipment
Equity method investment
Other noncurrent assets
Accounts payable and accrued expenses
Equipment purchase contracts
Current portion of long-term debt
Other noncurrent liabilities
Redeemable noncontrolling interest
Noncontrolling interests in subsidiaries
Total net assets acquired
This pro-forma payment analysis was done almost exactly when the DRAM prices were at their lowest in Q4 2012, and Yen was about 82 to the dollar.
Cash: cash is cash, so it is rather hard to discount, but other assets such as inventories and PP&E have been valued at Armageddon values.
Based upon everything we can find in Elpida's bankruptcy documents, they have done far better than projected, so this cash should either be much higher, or the debt is lower, the equipment is higher, or they have hidden it in other current assets.
One thing we do know is Elpida paid down a $79M line of credit early and got Micron off-the-hook even before the acquisition. In the original sponsors deal, Micron could have had to support over $600M of equipment and credit lines, but never got deeper than $200M, much of which was paid-off before the close. So obviously Elpida had much more cash than what was expected.
Receivables - we do not have any really good information on what Elpida has been selling since September 30, 2012, so we cannot be precise here. However, we have some pretty good insights in the magnitude change. When these receivables were calculated, Rexchip, Elpida's 65% owned subsidiary, (now 89%-owned by Micron), reported monthly sales to Elpida of about $2.2 billion NTD that quarter, or $75 million per month, $900 million per year.
In the last quarter, Rexchip averaged $3.3 billion NTD, or $110 million per month, or $1.32 billion per year, nearly a 50% increase in revenues. It appears that Rexchip does not have all the benefit of the ASP increases, as they only provide wafers, no back-end services and margins - those go to Elpida (now Micron).
So even if the sales have only gone up by 50%, Elpida should be at a $4.2 billion run rate, and the receivables would likely approach $750 million. So if the receivables are $750 million (or more), then just from cash and receivables, Micron probably picked up close to $1.2 to $1.4 billion.
Next, look at the inventory of $870 million (which had probably been marked-to-market, and likely vastly undervalued). Fair value here means fair in the eyes of the buyer, where Micron may have a lot of incentive to be very pessimistic on the inventory value.
As of the closing, the DRAM market is now almost 2X compared to pro forma date. So does Micron now get $1.74 billion of inventory? No. The way FASB ACS 805 works may give Micron some ways to play funny accounting here. Also, remember Micron's incentive is to absolutely minimize the value of the inventory, as their deal is "cost-plus" of 5 to 10%. Any mark-up of the inventory now, just means MU leaves more margin in their Elpida subsidiary, where it comes back as a one-time equity adjustment and they will have limited usage of Elpida's cash until all bankruptcy debt is repaid, rather than as extra ongoing gross margin for a while, where Micron can use the resulting cash in other operations. This is where the accountants get to play some games. Yes it is all Micron money, but where and when it is recognized leaves possibly $500 million or more in a place where Micron can more easily use it.
Just like the old Contadina tomato paste ad, "How does Ms. Contadina get all of those giant tomatoes into that itty-bitty can?" - Micron is going to have to figure out how to do rational valuation allowances here, but does open up a serious opportunity for accounting mischief (by grossly understating what they bought), which means BIG gross margins going forward as they burn down grossly-undervalued inventory, and have little depreciation while their competitors have to play with real accounting rules.
So when Micron finally puts out an 8-K (or their balance sheet on September 23rd for FY 2013), take a deep dive into this number as it will tell you a lot about how they are accounting for the acquisition and whether they put away a $1 billion to $3 billion slush fund for a rainy day.
Elpida made a $2.828 billion impairment charge to long-term assets after their bankruptcy filing, at about the low-point of the DRAM pricing. That is a pretty big write-off, particularly now that DRAM pricing has doubled. In 2012, 2011, and 2010, Elpida had Cap Ex of well over $2 billion. The vast majority of that Cap Ex is what is making those high-priced DRAMs now. Even if you do five-year depreciation, those three years should still have over $1B of value - after you write-off 100% of all historical investments.
Basically, for the initial payment of $612 million, Micron gets 100K wafer per month, 300mm, 30nm and 25nm DRAM fab. the replacement value of such a fab is $4-5 billion.
Now let's look at Rexchip. Micron just paid $334M for 24%, and it got 65% for "free" as part of Elpida. If you apply zero value to control ownership of equity, that 65% would still be worth $931M. The Rexchip fab, at 85,000 wafers per month would have a replacement value of $3-4 billion.
So it is hard to value Elpida's factories and equipment and the Rexchip investment at much less than $2 billion to $4 billion. If they choose to do so, it will be based upon some valuation adjustment rationale which grossly understates true value. If you look at Elpida's Net PP&E on Mar 2011 and Mar 2012, it went from over $7 billion to $4 billion via the impairment charges, while since November 2012, DRAM prices have more than doubled. So Micron just bought factories worth over $4 billion in March of 2012 (after the $2.8 billion of impairment) for zip, nada, zero, zilch... when you factor in cash, receivables, and inventory.
By comparison there is news that Samsung is building a $7 billion facility in China over the next year to start in 2014. It will be new equipment and therefore able to process smaller geometry processes, but it is unlikely to be as large as the Elpida 185,000 wafers per month. So if Micron does not report $2 billion or more for the Rexchip and Elpida investment and PPE, this will end up coming out as better gross margins due to vastly understated depreciation going forward.
Elpida reported over $1 billion in depreciation alone in 2011, or about $1.00 per MU share. It also reported paying over $150 million in interest. If you take those numbers out of Elpida's operating statements, they only lost a few hundred million in the year before bankruptcy. Had Elpida not had a big debt payment due in March 2012, they would not have filed bankruptcy. Had their creditors advanced Elpida $500 million while doing a standstill during the DRAM trough, Elpida debt/equity would probably be worth over $7 billion today. So basically Micron bought that for $612 million cash, and a note to be paid out over the next six years at zero interest.
SanDisk (SNDK) is a much better company than Elpida, but from a manufacturing standpoint, SanDisk's annual capacity is about 2.5 million wafers, and Elpida/Rexchip is about 2.2 million. So you can also view it as Micron just bought approximately SanDisk's manufacturing capacity for nothing.
The current Micron/Elpida position:
On December 31, 2012, Micron had only 65,000 DRAM wafers per month Taiwan (Inotera), and none from Japan. With the restructure of the Inotera contract, it is now getting 130,000 from Inotera, plus the 85,000 from Rexchip, and 100,000 from Elpida Japan. Add the DRAMs made in Singapore (converting to NAND over the next year) of 60,000, and probably under 40,000K DRAM wafers in Virginia, and Micron went from having a DRAM capacity of 165,000 per month, to now over 415,000 per month, which means they will have almost the same DRAM wafer capacity as Samsung.
So Micron has added almost 250,000 DRAM wafers per month over the last seven months. Almost as much DRAM capacity as SK Hynix has in total capacity! Total Micron cash out is less than $1 billion. SK Hynix has about 400,000 wafer per month across DRAM and NAND. Now Micron owns or controls almost 600,000 W/M. Hynix has a market cap of $17 billion, but after the Elpida deal, is only about 2/3rds the manufacturing size of the new Micron.
Micron stated in their press release of July 31, the 185,000 wafers from Elpida and Rexchip increase their capacity by 45%, which means they had about 411,000 wafers on July 30 (including maybe 130,000 from Inotera). So at Micron-owned fabs, they only had about 300,000 wafers per month, where probably 40,000 are the IMFT Intel NAND JV wafers in Lehi UT, which are sold roughly at-cost to Intel.
So what are the industry implications for Elpida now being Micron?
Micron has scattered its DRAM manufacturing across the planet from Virginia to Singapore. Over the next two years, it is likely all DRAM manufacturing will concentrate in Japan and Taiwan, and MU will only make NAND-type NVM products in their other factories.
In March 2012, Micron and Intel restructured their NAND partnership in a way that moved about 60,000 NAND wafers over to Micron from the JV facilities in VA and Singapore for a total of $600 million, where Intel even financed the deal.
Remember, after all of the transactions Micron has done over the last 18 months, they did not increase industry wafer capacity, they only moved it under their corporate umbrella. So no new capacity was created here, just gobbled up by Micron for a song.
So what is the bottom line of the Elpida acquisition?
Micron jumps from the fourth largest memory manufacturer to the second largest with 50% more capacity over third place SK Hynix.
Micron also gets to rationalize its manufacturing and concentrate DRAMs only in Japan and Taiwan, and NAND in the US and Singapore, and leverage its R&D far more intelligently.
Being the #2 Worldwide supplier of DRAM changes the game for buyers in what is now a 3 vendor market. Micron is no longer competing with countries who are willing to lose money in order to build a semiconductor industry, it is competing against two private firms that are also not competing against irrational prices.
Have you tried to rent a car recently? Have you bought an airline ticket? If so, you know what happens when competition shrinks to three or fewer competitors. Those analysts who are predicting DRAM and NAND pricing collapses and gloom and doom over the next year, are either predicting a worldwide recession, or they simply don't understand the real situation.
Someone called this the DEAL-OF-THE-CENTURY in DRAMs. In Micron's latest 10Q, it showed net assets of $8 billion (after deducting liabilities and equity). By comparison, Elpida showed gross assets of 764 billion yen on 12/31/2011 (just before they went bankrupt). That was almost $10 billion at the time, now it would be $7.6B. Micron paid $612 million real money for those assets.
You now understand the Micron/Elpida deal is the STEAL-OF-THE-CENTURY.
Remember you heard it first at Seeking Alpha.