When we wrote part 1 of this article on February 16th, Elpida was on its last legs and not quite in bankruptcy -- it actually still had billions of yen in market cap. Now, bankruptcy bids have been submitted, and according to NHK, Micron (MU) is the winning bidder. We may not find out for days, or even weeks, whether Micron or a TPG/Hony Capital bid is the winner. Regardless, we expect a DRAM oligopoly dominated by Micron, SK Hynix (000660.ks) and Samsung (SSNLF.PK).
With a handful of dominant players, as well as a solid DRAM backdrop (few capacity additions, new OS from Microsoft (MSFT)), we expect DRAM prices to rise over the remainder of 2012, indirectly benefiting several players while hurting others.
DRAM producers - A firm DRAM environment should significantly help Samsung and SK Hynix. The exit of Elpida, the industry's third largest player, should reduce overall competition - especially since the combined spending of Elpida/Micron is likely to be less than the two companies independently. Of course, Micron stands to benefit significantly if it wins, as the company would acquire capacity for pennies on the dollar and gain strong traction in Mobile DRAM-- a segment where it has been less competitive. In the unlikely event that TPG/Hony win, we would expect Elpida to be less formidable going forward, as we would be surprised to see the private equity funds to spend adequately to keep Elpida at the leading edge.
NAND producers - A firm DRAM pricing environment will give DRAM producers less motivation to convert capacity to NAND. Given the horrible price environment year-to-date, this could even result in conversion from NAND back to DRAM. This would be favorable for Sandisk (SNDK) and Toshiba (TOSBF.PK), as well as Samsung, SK Hynix and Micron, who have all seen year-to-date improvement in the DRAM environment offset by weakness in NAND.
Semiconductor packaging - If Micron is the winning bidder, it could be very positive for ChipMOS (IMOS) which packages and tests DRAM for Micron (its 2nd largest customer) and others. ChipMOS should benefit from a better DRAM environment as 34% of its revenues come from commodity and niche DRAM. Moreover, should Micron choose to consolidate Elpida's Akita facility and outsource assembly and test to ChipMOS, ChipMOS should be well positioned for incremental business given its recent acquisition of a 393,000 facility. While Elpida has traditionally outsourced to Powertech International and Walton, we note that when Micron began outsourcing, it chose ChipMOS instead of both those vendors. According to ChipMOS' annual 20-F filed on April 26th, revenues from Micron grew over 30% in 2011, from 2010, despite a horrible DRAM environment. Clearly a Micron win could be material to ChipMOS, (which trades at just 3x trailing free cash flow).
PC, Tablet and Handset Manufacturers - A stronger price environment and greater supplier bargaining power poses a risk to Apple (AAPL), Dell (DELL) and Hewlett Packard (HPQ). Their margins can be negatively impacted by rising commodity prices. Should pricing rise over the next few quarters, this could show up in their results. That said, as Dell and HPQ diversify to software and services, it is likely the impact will be fairly limited. Firm DRAM pricing could help result in firmer NAND pricing which could hit Nokia (NOK), RIM (RIMM) and Apple, Amazon (AMZN) with their Kindle, and Barnes & Noble (BKS) with their Nook. We'd expect Apple to be relatively advantaged against tablet / handset vendors (except Samsung) given their preferential pricing.
Consumers - Higher prices for components means higher prices passed on to consumers for memory upgrades and slower migrations to higher memory densities. Still, relative to the total cost of a system, the hit should be fairly modest.
Bottom line - We are very positive on the outlook for DRAM over the course of 2012. With limited DRAM supply increases, an industry oligopoly, Windows 8 from Microsoft on the horizon, and seasonal strength ahead, we see much better times ahead. Our favorite single stock pick is ChipMOS, given its leverage to DRAM broadly and Micron specifically, and absurd valuation of 3x trailing free cash flow and 1.5x trailing EBITDA
Additional disclosure: We conduct thorough research on our ideas, but our views are our own. Please do your own research.