By David Sterman
Think about your family and friends. How many of them have recently bought traditional computers and how many have bought tablets such as Apple's (NASDAQ:AAPL) iPad?
While many tech users (especially at companies) will still need to the horsepower of a good old-fashioned computer, tablets are clearly likely to be the future choice for most. This logic has helped push shares of Micron Technology (NASDAQ:MU) down to a two-year low (shares are currently trading at about $5.50). But investors may want to take a fresh look at where the company's technology and growth opportunities are actually headed. The future is much brighter than the lagging stock chart may indicate.
Make no mistake, Micron's traditional focus on computer memory -- known as DRAM, or dynamic random access memory -- has become a millstone in recent weeks as pricing plunged to multi-year lows. This was due to a slowdown in demand for DRAM, which caused a glut of chips. The good news is pricing is likely to improve later this year.
Tablet makers such as Apple don't like DRAMs. Instead, they prefer flash memory, which uses less power, has a smaller form factor and can handle more processing tasks that were traditionally left to the core microprocessor. Micron saw this trend coming, so it made major investments in 2009 and 2010. As a result, the company -- along with Sandisk (SNDK) -- has become one of the world's leading providers of flash memory.
And unlike traditional memory, this flash technology has another application. Instead of hard-disk drives (HDDs) made by companies such as Western Digital (NYSE:WDC) and Seagate (NASDAQ:STX), tablet manufacturers are making drives that use flash technology, known as solid-state drives (SSDs). These devices lack the moving parts of traditional drives and are far less likely to crash than a traditional HDD. This opens the door not just for tablet computers, but for traditional computers as well.
Indeed, a wide range of technology devices, from smart phones to automotive electronics to industrial process-control equipment, are being developed to utilize SSD. This is why Sterne Agee's Vijay Rakesh says we're "at the beginning of a new revolution as some of the markets start to establish themselves and ramp." Rakesh says the market for Micron's SSDs is under 10% of the broader computing market today, but will be more than 40% by 2015.
Whereas Micron has shared the traditional DRAM market with many Asian competitors, it looks to have a much more dominant role in the SSD market, thanks to heavy research and development (R&D) spending. The Asian rivals have been dealing with much weaker balance sheets, forcing them to scrimp on R&D. Japan's Elpida (OTC:ELPDF), Korea's Hynix (OTC:HXSCF) and Taiwan's Powerchip (OTC:PWSCF) carry $3.3 billion, $3.5 billion and $1.5 billion in net debt, respectively. Micron, in contrast, has $2.4 billion in cash and $1 billion in net cash.
The balance sheet difference could also affect the legacy DRAM business. Prices have fallen so sharply, most players are making no money on their DRAM chips. Japanese and Taiwanese firms have already sharply cut production due to biting debt loads. Whenever this happened before, the glut was reduced and DRAM prices rebounded. So even though Micron's DRAM segment will likely look pretty weak in the fiscal fourth quarter (that ended August), results in coming quarters should show real improvement, aiding already-strong pricing and demand dynamics in the newer SSD/flash market.
This should coincide with a pullback in Micron's heavy slate of capital investments, since the company recently sought to strengthen its technology platform and manufacturing capabilities. Capital expenditures are slated to drop from $2.9 billion in the fiscal year ended August to $2 billion in fiscal 2012. As a result, free cash flow could approach $500 million in the fiscal year that begins after Labor Day, and top $1 billion by 2013, according to Goldman Sachs. This would translate into a free cash flow yield of nearly 20%.
Asian memory makers are cutting output, which should help stabilize and eventually boost pricing for these types of chips. Micron's stock may fail to appreciate from current levels until the change in pricing is in evidence.
Micron's bullet-proof balance sheet may be the real appeal of this story. The company carries $8 a share in tangible book value -- more than 30% above the current stock price. Management is using it to maintain technology leadership and to buy back stock (a $150 million stock buyback plan is currently underway). Assuming Goldman Sachs' free cash flow projections come to pass, the company may pursue additional buybacks after the current one is completed, especially while shares remain so far below tangible book value.
Investors would do well to contemplate the upside potential of this stock further. You may find it to be a valuable pick-up.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.