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Monday, December 22, 2008

Sure, what the hell. Let's bailout DRAM too.

I understand bailing out the banks. I get bailing out the autos in spirit. I do not understand bailing out DRAM companies.

In recent weeks prices of commodity memory parts have collapsed due to widespread cancellations rippling through the PC supply chain. Memory manufacturers were already very weakened heading into the inventory destocking. Many of the Asian manufacturers like Hynix, Promos, Powerchip have been losing money for over a year now due to industry overcapacity. Qimonda of Germany is virtually insolvent.

As I've been talking about forever, semiconductor capital equipment companies had a larger percentage of orders and revenue coming from memory manufacturers than at any point in their history. It represented over 50% of Applied Materials book and they are one of the more diverse companies in the space. At companies like Lam Research and Mattson, memory was 80-100% of orders at the peak.

It is only in the last 9 months that any meaningful capacity cutbacks have been implemented. For the most part, these cuts have come in the form of capital expenditure reductions. Existing capacity has begun to see some real output cuts in the last quarter or so with Toshiba, Samsung, Hynix and assorted others reducing output to try to conserve cash. For the last several years, memory manufacturers have tried to produce as much commodity memory as possible in an effort to improve gross margins -- but gross margins have been negative throughout the industry in the latest leg of the downturn. There's no way to spend through that.

South Korea has been actively discussing further supporting ailing and failing Hynix. Taiwan is exploring ways to financially support their domestic DRAM business and is presently trying very hard to negotiate a bailout package. Qimonda managed to negotiate with the state of Saxony in Germany to pull down a 325 mil euro loan and an option to tap future federal aid.

Following announcements by Toshiba of a two week furlough of production and another 30% capacity cut from Hynix, DRAM and NAND prices have risen significantly. As the supply chain has been awash in parts for the last several months, the moves are very encouraging.

The strength in DRAM prices has begun to drag NAND prices higher -- particularly MLC parts. I prefer NAND plays to DRAM plays as I think falling NAND prices will boost solid state drive adoption -- and that's a new market for NAND. DRAM just doesn't get a lot better without some breakthrough application that eats up memory and I don't see it. NAND has a massive and virtually untapped opportunity in SSD and each SSD drive uses up multiple parts relative to their current end markets of mp3 players, digital cameras and cell phones.

The structural industry problems in DRAM remain. Too much capacity is not typically solved by more cash to burn. Capacity cutbacks are a reason to be bullish. Government bailouts are going to keep unprofitable businesses running, though, and that's not good for anyone.

PCs rarely require more than 4 gb of memory so there's a ceiling of sorts there. Low cost netbooks are the fastest growing portion of PC growth right now and they are typically configured with 1 gb of memory and cap out at 2 gb. There are not many new markets being addressed for the parts.

So I won't be chasing Qimonda (QI) or Micron (MU), though I suspect Micron is actively negotiating in Taiwan to cut themselves a good deal.

Sandisk (SNDK) owns all the NAND intellectual property and quite a bit of the royalty stream -- I suspect when Samsung ultimately cuts themselves a better royalty arrangement it will be the last shoe to drop for the stock. The quarter isn't good. The outlook won't be good. The stock trades for 4-5* the royalty stream, though, and that makes it tough to be negative on the stock here. The real question is going to be on the balance sheet -- what does it look like as they keep backpedaling out of the Toshiba joint ventures. Time will tell.

STEC recently lowered guidance due to weakness on the DRAM side of their business. Allegedly the NAND drive side remained healthy... at least relatively healthy. It's an interesting spec at $4.

I can't get bullish on semicap plays yet though I suspect we're looking at the worst of the order patterns and the rate of deceleration is at it's peak. I don't see why order patterns would improve much near-term. I could see them stabilize, though, and maybe that will bring people into the stocks to bet on a recovery. My suspicion is we drag along the bottom for a while but massive government interventions could provide short-term capital and keep orders from dropping further... which would seem wildly bullish comparative to the last several quarters of trend.

I am long a little Sandisk. I hold no positions in any of the other stocks mentioned.

1 comment:

ShortBus said...

Thank you for your commentary on this area of the PC memory market. Well work the read every time. I am a loyal regular reader.

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