It's a classic conundrum. What do you do with a well-run company
in a very tough industry? Do you focus more on the company's solid
balance sheet
and growth opportunities, or focus on the key issues beyond the
company's control?
That's been the biggest challenge facing investors in
Micron Technology (NYSE:
MU
)
.
This past September, I
laid out
why I think this company is poised for a great future. And for a
while there, the broader investment community was in agreement.
.jpg)
The stock's rebound began in December after a favorable legal
verdict, which I discussed
in this article
.
And
shares
kept on rallying as prices for DRAM (dynamic random access memory
-- what's used to store and retrieve data in computers), firmed up.
Yet as DRAM prices have slipped anew, shares have given back the
recent gains.
That's why a soon-to-be released announcement from Micron is so
important. The company is hammering out the final details of a
major
acquisition
that should help control the industry supply of DRAM, enabling
producers to steadily garner firmer prices for their products.
A glut will soon end
.JPG)
Japan's Elpida was like the unwanted neighbor that shows up at your
parties. The DRAM producer kept flooding the
market
with its DRAM chips, even though it was losing gobs of money. All
that Micron and rival Samsung could do was hope that demand would
outstrip all that supply, which has rarely been the case in recent
years.
Elpida's money-losing ways finally forced it in to bankruptcy, and
after protracted negotiations, Micron has apparently agreed to take
over the struggling firm for around $2.5 billion to get Elpida's
assets, which is likely $500 million or even $1 billion more than
it had initially hoped to pay. And Micron will likely spend another
$1 billion to shore up the acquired manufacturing plants. But the
stiff price will still be worth it.
At that price, Micron is getting Elpida's assets at $0.30 on the
dollar, if the company were to make similar capacity enhancements
on its own. Elpida's Hiroshima plant is said to be worth $3 billion
and the Rexchip plant another $5 billion. And the purchase price is
still less than half of Elpida's $5.4 billion
debt load
when it skidded into bankruptcy.
More importantly, a field of four major players has just been
reduced to three (Samsung has around 45%
market share
, and Micron and Hynix will each have around 25%). That sets the
stage for more controlled industry output, as the industry's loose
cannon (Elpida) will no longer be flooding the market. In fact,
Micron is likely to shut off some of Elpida's capacity simply to
make sure industry supply will be in sync with demand.
What's the eventual payoff? Well, analysts are just starting to do
the math. Credit Suisse, for example, thinks the deal, in a best
case scenario, could add $0.70 in
earnings per share (
EPS
)
to Micron, or $720 million in
cash flow
. Most of those gains would come from further price hikes in DRAM.
In an absolute worst case scenario, they see the move as neither
helpful nor hurtful. They're splitting the difference on the range
of assumptions, and have come up with a $12
price target
(the stock currently trades for a little more than $6 right now).
Analysts at Citigroup have a similar take: "We view this deal
favorably given it is
consolidation
in a
commodity
industry, is cheap relative to replacement cost, and strengthens
MU's relationship with
Apple (Nasdaq:
AAPL
)
." Apple was Elpida's largest customer, and apparently lobbied for
Micron to gain control of Elpida. Citigroup's $12 target assumes
shares will trade past the current $8 in tangible
book value
and move up to 1.5 times that figure.
As noted earlier, slumping DRAM prices have been a recent
impediment for this stock, but help is on the way, according to
Goldman Sachs. Earlier this week, the firm issued an updated
industry forecast, noting that the market will likely remain
oversupplied in the current quarter, move into balance in the third
quarter, "with the potential for meaningful undersupply in 4Q12."
Their key takeaway: "Given a tightening supply/demand balance, we
believe pricing is likely to continue moving slowly higher over the
coming quarters."
Risks to Consider:
To pay for the Elpida deal, Micron will be issuing fresh debt,
and the interest rates it will have to pay will help determine how
strong a payback it can expect from the purchase.
Action to Take -->
It will take several quarters for all of this to play out. Indeed,
the agreement in place may still fall apart before the paperwork is
signed. But assuming the deal gets done, analysts will increasingly
start to see what this industry will look like in a year or two, as
industry supply gets rationalized. That should push this stock,
which already trades at a sharp discount to tangible book value,
back on to
Wall Street
's buy lists. And if the analyst price targets I mentioned earlier
are indeed where this stock is headed, then we're talking about a
double.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.