Micron Technology (MU) said that it will buy bankrupt Japanese memory maker Elpida Memory for $754 million in cash. This also includes Elpida's $1.75 billion in debt with annual installments until 2019. The company will also pay $334 million to gain 89% of Rexchip. This brings the total acquisition cost to $2.8 billion.
These acquisitions look promising for the company. Elpida owns a chip fabrication factory in Japan. On the other hand, Rexchip has a testing site in Japan and manufacturing site in Taiwan. This will give Micron a strong foothold in Asia. In addition to that, both assets of Elpida and Rexchip can produce 200,000 300mm wafers per month. This is approximately 50% increase in Micron's current manufacturing capacity.
According to Wall Street Journal, it has expressed its intention to acquire a rival dynamic random access manufacturer (DRAM) in Asia. In fact, it attempted to acquire SK Hynix in 2002 for $4 billion but the deal was not successful as the creditors of SK Hynix opposed the transaction. They were concerned that the company will fall into foreign hands.
The outlook for the DRAM market has improved, notably in the Asian region. Hynix expects that the second outlook will be better with the improving prices. It appears that Asian firms have benefited with the fall out of Elpida. Elpida corners 11.9% of the global DRAM market. There have been declines in the supply as firms have cut back on their investments since last year.
Industry Consolidation Will Result in Price Stability
The acquisition of Elpida will result in a more concentrated DRAM industry. According to iSuppli first-quarter market share data, the top three DRAM manufacturers constitute 77% of the total market share. Micron will become the second-largest DRAM maker with a market share of 24.8% following this transaction, nearly double from its market share pre-Elpida acquisition. The company has already surpassed Hynix with a market share of 24.2% and is currently trailing Samsung's market share of 40.8%.
This deal will reduce volatility in DRAM prices as Micron and the rest of the market leaders will have better control over production capacity and investment needs. This will also bring renewed growth in the DRAM industry. For the next few years, DRAM revenue is expected to exceed $30 billion a year and will reach $39 billion in 2016. This is good news as the industry posted a surprising 25% contraction last year.
On a historical perspective, DRAM chips manufacturing required huge investment outlays in both technology and plant. Bigger capital investments made in the previous years have led to overcapacity. This eventually resulted in lower prices, notwithstanding price-slashing effects of competition. Also the Thailand flood late last year resulted in perceived scarcity of hard disk drives, which significantly affected PC sales.
Industry pundits believed that DRAM demand has improved given the increased demand in tablets and smartphones. The new entrants of the tablet space including Microsoft (MSFT), Amazon (AMZN) and Google (GOOG) have confirmed that there is strong demand in this space. As the industry has recovered, the Elpida acquisition seems timely as Micron and others will be able to capture strong growth of tablet makers and smartphones.
There are only few concerns related to this acquisition. The company's track record of integrating its past acquisitions to its own process is questionable. However, I believe that the company has learned its lessons well with this big-ticket acquisition.
Deal will not Stretch the Company's Financials
Based on the recent quarterly filings, the company has cash and cash equivalents of $2 billion. I believe that the company will borrow money to finance this acquisition as free cash flow is still negative. Given that debt to equity is still low at 27% of equity, borrowing money makes sense. The good news is that cash flow will also not be stretched as the deal is not expected to close until the first half of 2013.
The company is expected to turn around its operations next year. It is expected to earn $0.23 per share next year, a reversal from this year's loss per share of $1. For the next 5 years, the company is forecast to grow earnings by 12% a year. This is due to the strong prospects of the smartphone and tablet makers.
Operating margins have also improved to 8% for the last year. This is a continuation from the prior year's operating margins of 18% coming from operating losses three successive years. This is also in line with the recovery of its peers. SanDisk (SNDK) has average operating margins of 23% coming from operating losses in 2008. Meanwhile, semiconductor company Spansion (CODE) is still experiencing operating losses, but the losses narrowed for the last four years. Spansion is also expected to post earnings per share of $1.69 this year, implying a growth of 81% from this year's estimated earnings.
The stock is currently trading at 29 times 2013 earnings. Over the last 5 years, the stock has traded between 4 times to 35 times earnings. Looking at these current valuations, it seems that Micron's valuations are not stretched. This is despite the lower valuations of its peers. The average industry price earnings ratio is at 20 times.
Semiconductor giants also have lower multiples. Intel (INTC) trades at 11 times earnings and carries a dividend yield of less than 1%. Sandisk is also valued 10 times earnings and Mosys (MOSY) trades at 14 times earnings.
If analysts are right, the company will earn $0.44 per share in the next three to four years. I also believe that a 35 times earnings multiple appears to be achievable as industry conditions have improved. At these levels, the stock should trade at $15. This implies an upside of 1.5 times from the current price levels.