While the storage and memory segment of the technology space does not tend to have the appeal of consumer product manufacturers like Apple (AAPL) and Google (GOOG), or even chip makers like Intel (INTC), it is an extremely attractive part of the equation with significant growth potential. To this end, when two major players like Micron Technology (MU) and SanDisk (SNDK) announce a shift in their strategic focus, it has real investment consequences and potential. After sifting through the alphabet soup discussed in greater detail below, the message is simple: each of these two industry leaders are turning their attention to a growing segment of the market, which will have the potential of shaking up the relative positions of each company involved.
The Shift to Solid State
Late last week, both Micron and SanDisk announced that they will likely be shifting focus from NAND flash memory drives to solid state drives ("SSD"s). As the devices that rely on memory have begun to change form - away from notebooks and toward smartphones and tablets - flash memory solutions have taken off. Where it is nearly impossible to instill a huge hard drive in a smartphone, adding flash memory has become relatively simple. This is not to suggest that hard drives are likely to disappear, but they will become limited in their application. Higher-end notebooks that need large memory capacity will rely on SSDs because they not only allow data to be accessed more quickly, they tend to be more stable and durable. Where things become interesting is when one realizes that SSD technology is highly dependent on NAND technology. Mark Newman of Bernstein Research writes:
"On the demand side, we see SSDs including Cache/Hybrid HDDsto keep driving bit demand, growing from 14% in 2011 to 39% of overall NAND GB demand by 2015 -see Exhibit 22. We estimate GB demand to grow 71% in 2012 and a further 62% in 2013. In contrast we see no wafer growth, and with GB/wafer growth falling as technology advancement begins to slow down we see a large gap developing between supply and demand that must be filled with additional wafer capacity by 2013 2Q. Without capacity adds the NAND industry will fall into dangerously low inventory levels and extreme undersupply by 2H 2013."
With Micron and SanDisk increasing their participation in this market segment, some of the supply concerns should be addressed, but both companies should be well positioned moving forward. Each possesses certain strategic advantages that have the potential to result in significant rewards.
The Impact on the Industry
The two competitors most likely to be impacted by the move by Micron and SanDisk are Seagate Technology (STX) and Western Digital (WDC). Both companies operate in the SSD space and will experience significant pressure because one of the highest cost components of SSD is NAND. The impact for Seagate and Western Digital are two-fold: first, the entry of these new competitors is likely to steal market share from each company; and second, there is a real chance that with Micron and SanDisk entering the space, competitors will need to find new suppliers of NAND. Both Micron and SanDisk are well run companies that should be able compete in this space. Both companies are able to fabricate NAND, which is not only quite expensive, but getting up to speed on fabrication is arguably prohibitively expensive to enter. This means that the ability of each company to produce NAND may give them an "uncatchable" advantage for the foreseeable future.
Micron may have an added advantage as the result of a recent acquisition. Like many of the players in this segment, the company operates in the DRAM memory space as well. While growth in DRAM memory for PCs appears to be stagnating, an increased demand for DRAM in smartphones could make this another critical area. Micron recently acquired bankrupt memory maker Elpida. The infrastructure required to fabricate DRAM is very expensive, particularly given the tight margins that exist in the DRAM space. The acquisition should boost Micron's market share from 12 to 13% and take it to 22 to 23%. This will provide the company with another critical area in which to compete and potentially dominate.
While many investors tend to prefer stock recommendations to be limited to a single name, in this case a balanced approach between Micron and SanDisk seems to be the most sensible approach. The small advantage that should be given to Micron based on its DRAM business goes to SanDisk in terms of various financial metrics. Where SanDisk has a trailing twelve month price-to-earnings (P/E) ratio of 15.6, Micron has no P/E due to negative earnings. This also means that at current levels, Micron has a negative operating margin and a negative return on assets. SanDisk has an operating margin of nearly 20% and a return on assets of 6.6%. Micron was able to achieve year-over-year revenue growth of 1.5% relative to negative growth of nearly 25% for SanDisk.
The take away from the statistics, the news and the relative industry positions is that the prudent acquisition is of both stocks. The two companies together balance the strengths and weaknesses of the other and both remain favorites of several analysts. Given the direction that each company is looking towards for growth, owning the two in tandem should prove profitable.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.