Recent Inotera Acquisition Could Limit Downside Risk To Micron Stock In 2016

  • Micron Technology has announced that it will purchase the remaining majority stake in DRAM manufacturing partner Inotera Memories for $3.2 billion.
  • The move to purchase a DRAM company appears odd considering how badly the DRAM market has been battered in 2015.
  • The move implies Micron remains bullish that the DRAM market will recover in the not-too-distant future. This could limit the downside to Micron stock price in 2016.
Inotera acquisition could limit downside risk to Micron stock

DRAM and NAND memory manufacturer Micron (NASDAQ:MU) has announced that it will buy the remaining 67% majority stake in DRAM memory manufacturer, Inotera Memories, for $3.2 billion. Micron already owns 33% of Inotera Memories, a joint venture formed in 2003 between Infineon and Nanya. Inotera’s DRAM sales already account for 35% of Micron’s DRAM output, which implies the deal will increase Micron’s DRAM sales by as much as 70%. Micron said the deal will have minimal impact on leverage, but will significantly increase the scale of cash flow. Inotera Memories has $900 million in free cash flow compared to Micron’s $1.2 billion.

Micron plans to take on $2.5 billion of debt to finance the purchase, which will increase its long-term debt by a substantial 39%.

Bullish on DRAM

Micron’s latest move to dramatically increase its DRAM capabilities appears rather strange considering the ongoing weakness in the DRAM market. Micron shares are down 60% YTD.

MU stock chart

Source: Micron stock price by amigobulls.com

The fall in Micron stock price is largely due to a dramatic decline in DRAM prices in 2015. For instance, the price of a 4Gb DDR3 module has fallen from ~ $30 in January 2015 to around $16 currently.

Micron-46

Source: Market Realist

About 39% of Micron’s top line comes from DRAM sales, with PC DRAM accounting for roughly half of that. Part of the DRAM oversupply has been brought about by the ongoing weakness in the PC market which has severely depressed demand for PC memory products.

The huge price decline has also been orchestrated by a large increase in supply by Samsung and SK Hynix, the two largest DRAM memory manufacturers. The two companies were able to significantly improve their DRAM yield rates towards the end of 2014.

Samsung in particular has been using more efficient and cheaper production processes in its DRAM manufacturing. The company was the first to employ 20nm processes in its DRAM production in 2014. The cheaper process has allowed Samsung to sell its DRAM chips at significantly lower prices than the market average. In fact Samsung is the only major DRAM manufacturer whose DRAM revenues have been growing steadily in the current year.

Micron-47

Source: Market Realist

Samsung plans to deploy 10nm nodes in its DRAM products in 2016, which might help the company to continue pricing aggressively and placing the likes of Micron under more pressure.

Micron has predicted that DRAM supply bit growth will clock in the low-to-mid-20% range in 2016. Meanwhile, most industry analysts expect DRAM prices to remain depressed in 2016, with a possible recovery in 2017.

With this kind of negative backdrop, it’s clear that Micron has something up its sleeve with its Inotera acquisition. Micron has been lagging other leading DRAM manufacturers in DRAM technology. Meanwhile, Inotera claims that not less than 80% of its DRAM wafer-start capacity will be based on 20nm nodes by the end of the current year. Inotera has been working hard to diversify its 20nm DRAM product portfolio to higher-margin products such as mobile DRAM. Inotera’s superior DRAM technology might explain why the company’s gross margin reading of 43% is significantly better than Micron’s 32%.

Mobile DRAM is the only DRAM sub-segment that has been able to resist price declines in 2015. By converting more of Inotera’s DRAM products for mobile, Micron can  weather DRAM weaknesses over the next 12-18 months before the expected cyclical upturn kicks in. This might help to limit the potential downside to Micron stock in 2016.

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