Micron: What Are They Hiding About Elpida, And Why?

| About: Micron Technology (MU)

Micron (NASDAQ:MU) 8K tells you they may be hiding over $2.00 of EPS from Elpida for a rainy day. Unfortunately Micron seems to want people to work to find out what they picked-up in Elpida. The recent 8K filing only has pro-formas through 2/28/13, and a few references to 5/30/13 numbers, but still those pro-formas do reveal a lot.

Now if you take their FASB 805 valuation of the justification for their $1.484B bargain purchase gain, which is summarized in their earnings release filing as well as their 8K, it answers a number of questions, but unfortunately requires one to make some educated guesses to try to figure out what REALLY happened at Elpida since 2/28/13, when DRAM prices have exploded higher.

So we have the unaudited pro-formas as of 2/28/13, and we also have Price Waterhouse "PWC" purchase accounting reconciliation as of 7/31/13. From that we can reconstruct almost all of Elpida's results for the five-month period, with one glaring exception: Capex purchased during that period. There we will simply have to insert a guesstimate based upon the two periods where Elpida disclosed its capex expenditures, 11 months ending 2/28/13 and year ending 3/31/12.

That said, one of the aspects of FASB 805 is the "measurement period" which offers some potential insight to what Micron might do before July 31, 2014. It might also explain why PWC allowed the $2.1B additional write-off (AFTER A RECENT $2.828B WRITE-OFF last year for a total of over $4.9B), which sure looks fishy. This gives Micron almost $2.00 of EPS cushion to play around with between now and July 31, 2014. During the measurement period, Micron can decide things were not as dire as they thought, and poof, Micron could instantly gain earnings which exceeded their cumulative retained earnings (loss) of $1.9B (or almost $1.80 EPS) through May 31, 2013. The ultimate instant slush fund.

From the 8K - "Elpida Acquisition Provisional Consideration and Valuation

The cash consideration paid for the Elpida Acquisition was $949 million which includes $615 million for the acquisition of Elpida and $334 million for the acquisition of the Rexchip shares.

"We estimated the provisional fair value of the assets and liabilities of the Elpida Group as of the July 31, 2013 acquisition date using an in-use model, which reflects its value through its use in combination with other assets as a group. These provisional amounts could change as additional information becomes available. These changes could result in material variances between the combined entity's future financial results and the amounts presented in these unaudited pro forma condensed combined financial statements, including variances in fair values recorded, as well as expenses associated with these items. The consideration and provisional valuation of assets acquired and liabilities assumed are as follows:

(Click to enlarge)

Changes in assumptions, estimates and judgments could significantly impact the asset and liabilities recorded as well as the gain recognized in the acquisition. The valuations involving the most significant assumptions, estimates and judgment included the following:"

The fair value of the noncontrolling interest in the table above primarily relates to Rexchip and was derived based on the purchase price we paid the Powerchip Group for their 24% ownership interest.

• Property, plant and equipment: Fair value in continued use and remaining useful lives.

• Deferred tax assets: Projections of future taxable income and tax rates.

• Inventory: Estimated future selling prices including the timing of product sales and completion costs for work in process.

• Debt: Discount rate and timing of payments.

Form 8

Fourth quarter financial conference call

Some highlights for the period of 3/31/12 to 2/28/13:

1 Apple was not a majority customer, rather it took no more than 24% of their production. It is possible they ramped-up later in the year to be a larger percentage of total revenues. No way to tell from the 8K.

2. It does not appear as if Apple provided any funding to help Elpida, rather just purchased product and evidently paid faster than other customers based upon A/R balances from largest customer.

3. It appears Elpida must have generated MORE than $1B of net asset growth (after adjusting for net debt before purchase accounting adjustments) in the five month period from 2/28/13 to 7/31/13.

Micron's write-off of $2.1B against the PPE.

What we know from the 8K is the following:

1. For the year ending 3/31/12, Elpida purchased 65,126M Yen of capex, or at the average Yen rates of under 80 Yen/$, $800M USD.

2. For the 11 months ending 2/28/13, Elpida purchased 16,719M Yen of capex, or at the average Yen rates of under 82 Yen/$, $200M USD.

3. Elpida recognized depreciation of 126,978M Yen and 65,126M Yen respectively for those periods, or a cumulative of approximately $2.4B USD.

4. As of 2/28/13, before Micron's $2.1B adjustment, Elpida had NET PPE of $2.947B. If you simply extrapolated the prior 11 month period, Elpida would have had about 30B Yen of added depreciation of roughly $315M. Not precise, but close.

5. If Elpida only spent at the 11 month rate of $18M/mo between 2/28/13 and 7/31/13, they would have purchased a total of almost $1.08B on capex from 4/1/11 through 7/31/13, or a 27 month period. Using a standard 5 year depreciation schedule, this equipment would have a net value of over $700M assuming the equipment purchases were evenly spread on a monthly basis.

6. So if Elpida ONLY spent $80M between 2/28/13 and 7/31/13, EVERYTHING EVER INVESTED IN PPE prior to 4/1/11 at Elpida and 65% of REXCHIP was only valued at $235M.

So the unanswered question is how much did Elpida spend on capex since 2/28/13? Because EVERY dollar above $80M, means Elpida earned almost another dollar more than we can tell from the 8K.

7. So if Elpida thought it had $4.7B of assets on 2/28/13 how did Micron get to their July 31 numbers?

So from the 8K how much value did Elpida add to their balance sheet before the adjustments Micron made?

(Click to enlarge)

So approximately $1.039B of net assets (after adjusting for growth of debt and Micron's purchase payment) were added to Elpida's balance sheet over a 5 month period ending July. To that amount you need to add whatever net capex occurred to get a sense of what Elpida actually had for operating cash flow and how it would translate to net earnings. So when Micron says Elpida had about $500 to $500M per quarter of operating cash flow, this analysis would support that assertion, possibly more if Elpida bought more than $0 of net capex (after depreciation) from February to July.

So a question for Micron. How much did Elpida purchase of capex from March 1 until July 31?

Unfortunately the analysts have already written their reports and are probably on to other companies. However, what the 8K does tell you is there is clearly much more to the Elpida story than Micron has yet to disclose. Assuming the 8K filing is accurate, the purchase accounting has already "swallowed" over $1B of operating cash flow, or $200M per month through July. To this number you need to add whatever net capex was spent.

So again, during a period where DRAM prices exploded higher, and Elpida is now cleanly out of bankruptcy, why on earth did Micron decide to take an additional $2.1B write-off? Unless Elpida and Rexchip have some mysterious problem or the DRAM market is going to tank, seems kind of hard to justify taking another $2.1B write-off on top of the $2.828B write-off from last year.

Answer seems pretty obvious. They now have a slush fund bigger than their retained earnings cumulative loss as of May 31, 2013. For those who value Micron on a price-to-book basis, you at least might want to know this. For those who value Micron on a P/E basis, you might at least want to know there may be another $2.00 EPS in the kitty. So for those who worry about whether Micron could meet earnings estimates in 2014, there is a hat with an almost $2.00 EPS rabbit in it.

Disclosure: I am long MU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.