On September 4 a fire in a computer memory fabrication facility in Wuxi, China, took a SKHynix (HXSCF.PK) plant, which supplies about 12% of the world's DRAM, offline. Reports on the time for a complete restoration vary from the company's chirpy "soon" to more dire reports that a clean room was breached and the cleanup and restoration of that part of the facility could take 3-6 months. It would seem that the spot market, reported nightly by DRAMeXchange.com, is voting for a longer restoration. The price of the reference 2Gb DRAM chip was $1.588 on 9/3/2013 and was $2.295 on 9/17/2013 - an increase of 44.5%.
The previous six articles in this "Memory Shortage" series here at Seeking Alpha have looked at the effects of past natural disasters, the introduction of the phrase "chip famine" into our lexicon, analysts' attempts to get their hands around supply and demand, and the effect a major new demand driver like Solid State Drives might introduce into this tight supply/demand situation.
So what does the Wuxi fire mean to Micron (MU)? Micron is very leveraged to DRAM, particularly after its acquisition of Elpida, completed on July 31, 2013. For its third quarter ended in May, Micron reported that 47% of almost $10 billion in annualized revenue was from DRAM. We know that almost 100% of Elpida's annualized revenue of more than $4.2 billion is DRAM. So if $8.9 billion in consolidated DRAM revenue were marked up by the spot market increase of 44.5%, the increase in revenue would be $3.96 billion. Lets back it off some and assume only a 25% increase in DRAM revenues, which would be $2.25 billion. With approximately 1.1 billion shares outstanding (depending on convertible note conversions) that would yield an incremental $2.02 earnings per share. Make your own assumptions on how long the Wuxi restoration may last and how long the spot market may be affected by the fire. For instance if the complete restoration takes six months maybe its fair to expect an incremental $1.01 in EPS based on the numbers above?
How important is the spot market? In the analyst day presentation on August 9, Micron management claimed the spot market was no longer very representative of its business. Management stated that it felt it was low volume, was more pertinent to lower quality chips, and didn't drive contract discussions as it used to. So perhaps it's unfair to assign undo importance to the spot market now that it is raging hot.
Imagine this scenario at Microsoft (MSFT) where poor young Mr. Snodgrass from purchasing is sent to break the bad news to Steve Ballmer as he is practicing his swan song:
Snodgrass enters the executive suite, knees trembling. "Mr. Balmer, sir, there's been a fire in Wuxi, China, and DRAM chips are no longer widely available or being given away. I know you just have unveiled a beautiful canvas for our late entry into the mobile business by buying the cell phone division of Nokia (NOK) for $7.2 billion. It would be a shame if we couldn't sell those beautiful $799 Lumia 1020 phones for want of a few DRAM chips. BTW, I love those cool TV ads for the Lumia that you got right out in a multi-million dollar ad splurge."
Ballmer growls, "Buy the damn chips but get us a six month supply. Pay whatever it takes since its such a tiny portion of this phone."
Snodgrass replies, "OK sir. How about the relaunch of the Surface tablet after the disastrous Surface RT experience? Sir, does RT stand for Really Terrible? Do you want me to buy chips for the relaunch as well?"
"Yes get them" replied Ballmer between bars to his swan song practice.
"Oh and sir," chirped Snodgrass, "How about the upcoming xBox with an order of magnitude more memory? Since we're supersizing it should we get chips with that?"
At this Ballmer ruminated. "Hmmm, maybe that Samsung (SSNLF.PK) outfit has something to its vertical integration. We could make cell phones, refrigerators and Window's software. Hey kid! What's the market cap of that leading independent manufacturer of memory chips, Micron? Maybe I should buy them before Tim Cook does!"
Conclusion. I'm betting the Wuxi restoration takes at least three months and that the chip markets remain in turmoil. So, per the numbers outlined above I think there might be an incremental $0.50 in EPS. I'll add that to the pre-Wuxi guidance Micron's Kipp Bedard has given of $3.50 in earnings per share. Hmmmm, $4 in earnings per share. Should I apply Intel's 12.86x PE multiple and get to a target of $51.44 per share? Or should I apply Sandisk's (SNDK) 20.71x PE multiple and get to a target price of $82.84 per share?
These share price targets are sounding like those advanced long ago here on Seeking Alpha by the inestimable Russ Fischer. Like all SA readers I owe him a huge debt of gratitude for early, clear, consistent and humorous dialog on Micron. While I was aware of the company from the J.R.Simplot days, it took Russ' excellent articles to break through my lethargy and indolence and buy my first shares and lots of options in early March. Hurray Russ! Hurray Micron!