It is rare for an acquisition to truly be a transformative deal for the company that is doing the acquiring. But in the case of Micron Technology (MU) and Elpida, we believe that there is still ample room for shares of Micron to rise.
We first profiled Micron on June 18, arguing that there is too much pessimism regarding the company's future, and that a potential deal for Elpida would be a catalyst for the shares to rise. Since then, shares of Micron have risen almost 17%, easily outperforming the S&P 500.
Elpida: Transforming Micron, and Changing an Industry
On July 2, Micron announced that it was buying Elpida out of bankruptcy for a total of $2.5 billion when everything is said and done. This deal will transform Micron, doubling its share of the DRAM market to 24%. And in mobile DRAM, Micron will now overtake SK Hynix and its 18.9% market share. The Elpida deal will nearly quadruple Micron's mobile DRAM share to 19.7%, placing it behind only Samsung with a 59.6% share. This deal will create a more rational pricing environment for memory, for it will allow Micron to have better control over supply gluts that have led to downward pressure on memory pricing.
This deal will lead to a 50% increase in Micron's total manufacturing capacity (alongside a related deal with Powerchip to boost Micron's stake in their Rexchip joint venture to 89%; that specific deal, while a positive, is not where the real catalysts lie). Furthermore, Micron gains control of Elpida's mobile memory business, which counts Apple (AAPL) as a key customer. Given the continued growth in the need for mobile memory, Micron's should see material benefits from its decision to acquire Elpida.
The Financials: A Clear Win for Micron
In our view, the financial terms of this deal may very well be the best aspect of it. CFO Ron Foster has said that this deal allows Micron to gain access to Elpida's manufacturing capacity at less than one-third the cost of building those factories themselves.
The fact that Micron would be the company to acquire Elpida has been known (or at least speculated) for some time, and the rumored purchase price, of anywhere between $2 and $3 billion ($2.5 billion was the most common number thrown around) caused some worries as to whether or not Micron can actually afford to buy Elpida. After all, Micron has posted several straight quarterly losses (although it is still cash-flow positive), and it has $2.325 billion in cash on the balance sheet, and net debt of $873 million. How could Micron afford to buy Elpida for $2.5 billion when it does not have the cash to do so? Would it issue stock, thus diluting investors? Or would it leverage its balance sheet even more? While Micron may have the financial strength to wait for a return to GAAP profitability, buying Elpida for $2.5 billion outright is not something that Micron could do easily.
The terms of the Elpida deal turned out to be more favorable to Micron than almost anyone had anticipated. Micron will be paying $750 million to acquire all outstanding shares of Elpida stock, and another $334 million to complete the Rexchip deal. All together, Micron will be spending $1.084 billion right away to double its market share and boost capacity by 50%. The remaining $1.75 billion in the Elpida deal will be paid in annual installments through 2019. This deal will wipe away all of Elpida's outstanding creditor claims, and Micron is doing so with far less pressure on cash flows or its balance sheet than previously expected. And CFO Ron Foster has said that Elpida's business is improving, and that this deal will contribute to earnings and cash flow within 12 months.
Analysts are upbeat about both Micron's dramatic expansion with this deal, as well as its financial terms, and we break down their reactions below.
- Nomura: Nomura reiterated its neutral rating and $8 price target, and writes that in its view, this benefits of this deal (specifically the price and terms) outweigh the execution risks present in essentially doubling the size of Micron. While Nomura thinks that consolidation in the memory industry is a positive, it is keeping its neutral rating because it wants to see more tangible evidence of a rebound in demand at Micron's NAND memory business.
- Wells Fargo: The firm reiterated its outperform rating and price target range of $10-12, writing that, "Over the last few years Micron has successfully diversified beyond commodity DRAM to establish substantial businesses in specialty DRAM, NAND flash, NOR flash and image sensors which we think could help improve profit stability somewhat. We believe that solid growth in the computer space will drive DRAM growth over the next several years. We view NAND flash as a segment that has high growth potential given the many new applications that NAND flash is used for." Wells Fargo sees this deal as being a positive for Micron, given the "favorable" deal terms.
- RBC: RBC kept its outperform rating and $11 price target, writing that, "terms of the deal are attractive, as we believe Elpida and Rexchip provide MU with considerable manufacturing scale and R&D synergies. We are encouraged on the ROI and visibility of when the deal becomes accretive to cash flows. While schedule and timing of the deal is largely in-line with our expectations, assessing Elpida's financial performance could be somewhat challenging in the near-term, though we believe the recent stronger DRAM pricing environment could help alleviate operating losses." RBC points to the financial aspects of this deal as strengthening, not weakening Micron's financial profile in the long-term, as the company's balance sheet and cash flows should strengthen as a result of the competitive advantages Micron will receive by buying Elpida.
- Sterne Agee: The firm maintained its buy rating and $10 price target, arguing that this deal came out much more favorably for Micron than had been anticipated. Sterne Agee wrote that, Micron announced the Elpida deal after months of speculation surrounding the deal structure and payback. We believe the deal is very smart and a pragmatic structuring for MU, with only $750M upfront, and the remainder $1.75B in "interest-free" installments through 2019. Also a fungible limited Capex outlay for Elpida in 2013, we believe this should be very agreeable to investors." Sterne Agee sees consolidation as a positive for the industry, and says that although at this point it is not altering its estimates for Micron, this deal removes a significant overhang from the stock.
In our view, Micron's best days are ahead of it. The company is transforming itself with this deal to gain control of Elpida, and we think that Micron will be a much stronger company going forward. The pessimism surrounding this company is unwarranted, and we think that even with a rise of almost 17% in the last 2 weeks, the company's stock is still undervalued. The next chapter of Micron's story is being written with the help of Elpida, and all indicators point to it being a profitable chapter, for both Micron and its investors.