Micron: 'AI Is Going To Eat Software'

Summary

• The world is gradually moving away from human-coded to AI-powered software.
• AI-driven software requires a higher content of dynamic random access memory.
• Semi-conductors were one of the first sectors to sell off as the recession unfolded but should be one of the first to recover.

In 2011, Mark Andreessen wrote a famed essay entitled "Why Software Is Eating the World". The paper was prescriptive in so far as virtually all industries were impacted by technology and many were vastly disrupted. Yet, writing software itself remains one area, somewhat ironically, that has not been "eaten" by software. This may be about to change. Jensen Huang, CEO of Nvidia (NVDA), was interviewed for MIT Technology Review, where he said, "Software is going to eat the world, but AI is going to eat software". If AI tools can write programs and solve problems that human programmers have been unable to tackle, then the world will enter a new paradigm. For certain basic tasks, such as image recognition, AI algorithms are already superior, i.e., more accurate than algos written by human programmers.

Now consider DataRobot, a tool that allows one to automate building and deploying advanced AI applications - without the need for human programming. In the world of testing, there are programs such as Mabl and TestCraft which use AI to test web applications and user interfaces. These tools may be implemented without coding skills. Diffblue uses AI to automatically write unit tests for Java that were previously done manually.

Micron (NASDAQ:MU) sits squarely in the epicentre of these trends. Its technology is used to power the infrastructure that facilitates artificial intelligence. The company’s high-capacity memory and multi-chip packages are used for AI training and inference engines - whether in the cloud or embedded in mobile and edge devices. However, there is a kicker. AI servers require six times the amount of dynamic random access memory (DRAM) compared with standard servers. As a consequence, the demand curve for DRAM is going to be different than what many expect if AI adoption accelerates.

A Supportive Industry Structure

The market share of the top five semi-conductor players now equates to around 80%. A more consolidated industry should lead to higher returns on capital. Cumulative R&D expenditure acts as a formidable barrier to entry. As demand begins to recover, the seeds are in place for multiple expansion.

Trade War Represents a Key Risk

Uncertainty around the trade war is high. Political leaders could lose control, which would put the semi players in a difficult situation. Supply chains are inter-connected, and disrupting them risks de-stabilisation. Micron has outsized exposure (13% of sales) to Huawei in China relative to peers, such as Broadcom (AVGO) (3.1% of sales) and Analog Devices (ADI) (7.8%). Banning component sales to Huawei clearly puts a portion of the revenue base at risk.

Cyclicality Necessitates Patience

The memory market remains cyclical. Whilst 2017-18 saw a down-cycle, there was a strong recovery in 2019 as the industry moved to a favourable demand and supply backdrop. As the COVID-19 crisis unfolded, there were concerns that NAND memory demand would roll over and take down pricing. However, as China has come back on-line quicker than expected and Western economies are poised to re-open, memory spend should accelerate, with NAND and DRAM leading the way, particularly as DRAM moves to more advanced nodes. In the short term, we should see a recovery in mobile in the second half of 2020. This would cause earnings revisions to take place faster than the overall market.

Summary and Valuation

Technology is at the front and centre of virtually every company and industry. We are in the early days of long-duration themes, such as artificial intelligence, 5G, robotics, automation and cloud adoption.

On May 27, Micron increased its Q3 EPS guidance to $0.75-0.80. The company trades at around 10x forward earnings, which is attractive in light of the long-term growth potential.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.