China, Idle Threats, And DRAM - Oh My!

by: William Tidwell

The Chinese OEMs' appeal to NDRC will have no long-term effect.

The episode is best seen as a validation of - "it's different this time."

The US and ROW must get involved to resist Chinese efforts to subvert world trade.

“By petitioning NDRC to investigate Samsung for monopolistic practices, Chinese smartphone brands hope that Samsung and DRAM suppliers following its lead will consider carefully before initiating the next round of price hikes,” says DRAMeXchange research analyst Avril Wu. SA – Brady Betz

“Toto, I've got a feeling we're not in Kansas anymore.” - The Wizard of Oz, by L. Frank Baum.

Folks who have been following and/or investing in the semiconductor memory industry, especially the DRAM producers, were treated to what can only be described as a surreal market reaction to a TrendForce report this morning. The TrendForce article reported an effort by Chinese mobile DRAM OEMs to pressure Samsung (OTC:SSNLF) to reduce, or at least to ameliorate price increases of DRAM memory. Seeking Alpha cited the report, focusing on the last sentence in the following quote.

“Nevertheless, NDRC’s recent action, along with slowing shipments from Chinese smartphone brands, will adversely affect the 1Q18 mobile DRAM market. The latest market survey finds that Samsung has taken the initiative in lowering quotes for Chinese smartphone makers even with the tight supply. The average sequential quarterly increase in mobile DRAM prices for 1Q18 is projected to reach just 3%, smaller than the initial forecast of 5%.”

The knee-jerk market response to that headline was to knock down Samsung shares by 5% and Micron 1%, presenting a wonderful buying opportunity on stocks that will soon be much more expensive, so that’s a good thing, but it’s the larger perspective on this episode that I think is worth our time exploring. Beyond the sheer stupidity of the market reaction, there are larger lessons to be gleaned from these events. So let’s get to it.

Lesson # 1. Welcome to Oz. We are not in Kansas anymore. Truth is, we haven’t been in Kansas for quite a while, but this episode well and truly drives a stake through the heart of the conventional wisdom argument that nothing has really changed in the memory business. The action of the Chinese smartphone OEMs could not speak more powerfully to that proposition. Apparently they didn’t get the message that DRAM prices would inevitably drop if they just waited out the cycle.

Lesson #2. While this Chinese action may have some short-term minor effects, it will have no long-term effect. China simply has no leverage short of realizing success in its super-risky long-shot memory initiatives, and those won’t pay off until the mid 2020’s, if then. All together now: In OZ it is different this time, and the NDRC appeal won’t serve as ruby slippers. Indeed, this new Oz has no ruby slippers – the DRAM business has changed fundamentally and there will be no return to the old cyclical model.

Lesson #3. Welcome to the opening round of the battle of the Sovereigns. China’s decision to entertain this action is a direct attack on what we might call the world trade order. The United States and the rest of the world must respond to what is a specious and cynical effort to subvert normal and entirely legal business practices. Samsung is not a monopoly – nor is there the slightest evidence that the memory oligopoly is conspiring to fix prices. The three memory oligarchs do have pricing power, but that is a function of unprecedented demand for its products, and not of an effort to withhold product from the market. Indeed, the memory industry (especially Samsung!) can point to historically high levels of CapEx in pursuit of bringing more and better product to memory customers.

Lesson # 4. The world has changed and will continue to change rapidly, as digitization is driven by a new, memory-centric computing model. Customers for memory may wish they could go back to the good-old days of low-cost memory, but that’s not going to happen. AI, IoT, edge computing, Big Data, and any number of other technology phenomena will continue to drive levels of demand that will challenge the memory industry’s ability to build sufficient capacity to meet demand. Indeed, a persuasive argument could be made that the industry needs 60-70% gross margins in order to have enough cash to meet growing capacity needs.

Lesson #5. The memory industry, if the companies didn’t know it before, knows now that it has a duty to build sufficient capacity to nurture and sustain the powerful technology waves coursing through the world economy. This is not to say that the industry has a duty to overbuild capacity, nor is it saying that the memory OEMs have a right to cheap memory just because that was the way it always used to be. It is another way of saying that with great power comes great responsibility.

Lesson #6. Saving the best lesson for last, memory investors just got a wonderful gift. Despite the absurd and irrational response of the algo-driven market today, Micron (MU), Samsung, SK Hynix (OTC:HXSCL)(OTC:HXSCF), and Western Digital (WDC) are excellent investment vehicles that will see higher multiples leveraging strong stock price growth over time – especially Micron!

Welcome to Oz, folks. Who wants to go back to Kansas anyway?

Disclosure: I am/we are long MU, WDC, NVDA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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