- Expect Micron's overall Debt/Equity ratio to come down slightly with the acquisition of Inotera.
- Operating income addition should be in excess of $600 million annually.
- It would put Micron in a better position to negotiate debt restructuring terms with its creditors.
It looks like Micron (NSDQ:MU) will be making headlines for the next few weeks at least. Its impending (and delayed) acquisition of pure-play memory manufacturer Inotera, is finally going to be completed in the coming December. This comes as a relief for all the anxious shareholders who were afraid that another postponement would cause the deal to fall apart. But more importantly, we can now finally start projecting the financial benefits of the acquisition on Micron’s financials. Let’s take a closer look to have a better understanding of it all.
Changes in Debt Levels
Let me start by saying that Micron is a highly leveraged firm. The chipmaker reported in its third quarter results, earlier this month, that its overall debt and net debt stood at about $9.9 billion and $5.5 billion. These figures may not mean much in isolation, so we need to have a reference point for a better understanding. To put things in perspective, Micron’s overall debt equates to about 82% of its equity, which is quite high considering the fact that other chipmakers such as Intel, Rambus and SunEdison Semiconductor operate with much lower debt/equity ratios of 39%, 30% and 46% respectively. But we’re here to discuss the future, not to dwell on the past. After all, investing is more about foresight than hindsight. So we need to have a better sense of how Micron’s debt situation would evolve once it acquires Inotera.
Investors should note that Micron would be raising about $2.54 billion in the coming weeks to fund its acquisition of Inotera. So the chipmaker’s overall debt liability would increase going forth. However, the key thing to note here is that Inotera, unlike Micron, operates with a much lower debt/equity ratio of 12. I went through the earnings reports of both companies and did some calculations, which are shared below.
(All figures are in USD Billions, Source: Company Filings, Compiled by Author)
Its worth noting that once the entities merge, and Inotera becomes a part of Micron, the total debt/equity ratio of the merged entity would equate to about 79%, which is actually a slight reduction from Micron’s standalone 82%. So, by acquiring Inotera, Micron is not only opening up a revenue stream for itself, but also slightly deleveraging its business.
This puts the merged entity in a good spot, in my opinion. Micron would be in a better position to negotiate terms of debt restructuring post acquisition. After all, the increased revenue and profit contribution from Inotera would reduce the risk of default on the merged entity’s loan repayments. The chipmaker currently pays a coupon rate as high as 7.5% on its notes, so there is ample room for rate reduction, as we also saw in the case of AMD. And credit rating agencies might as well re-rate the company (probably on the upside) with this factor in play.
Micron currently purchases all of Inotera’s manufacturing output. Last fiscal, the chipmaker paid out about $1.91 billion to Inotera in exchange. Obviously this is revenue for Inotera, but after deducting expenses such as manufacturing and operating costs, Inotera reports that it generated an operating profit margin of about 31%; its operating income for last year stood at just about $600 million. So we can expect this figure to get added to Micron’s EBIT going forward.
Also, both Inotera and Micron are pure-play memory companies. Therefore, once the acquisition is complete, there would be a significant room for cost reduction by way of slashing redundant equipment and jobs of overlapping roles. This would make the joint entity leaner and more efficient in terms of operations, work flow and profitability.
Micron also mentions the risk factors mentioned below, relating to sourcing its supply from Inotera in its FY15 annual report. These factors would disappear once the acquisition is complete and Micron would have better control over its inventory, cost of goods and ramping up expansion.
“Our Inotera supply agreements involve numerous risks including the following:
- higher costs for supply obtained under the Inotera supply agreements as compared to our wholly-owned facilities;
- difficulties and delays in ramping production at Inotera;
- difficulties in transferring technology to Inotera; and
- difficulties in coming to an agreement with Nanya regarding major corporate decisions, such as capital expenditures or capital structure.”
This would essentially make Micron a leaner and healthier company, with higher operating profits and lower leverage. A company that’s more agile in terms of expansion than before.
Putting it all together
Shares of Micron have been trending for the most part of 2016 and it looks like the trend will continue well into 2017 also. The acquisition not only boosts Micron’s profitability but also makes it a more efficient enterprise. I believe that analysts, credit rating firms and the investing community will take note of these factors and make bullish calls on the company, accordingly. Hence, I’m inclined to say that this is a great time to be bullish on Micron. Looking for winning tech stocks? Amigobulls' top tech stock picks have beaten the NASDAQ by over 111%.