With New Agreement Micron Gains Additional DRAM Capacity From Inotera

A strong operational performance and higher volumes from Inotera Memories increased Micron Technology’s (NASDAQ:MU) DRAM production in Q2 2013. However, the increased production led to a higher concentration of sales in the PC market which in turn caused a sequential decline in Micron’s DRAM average selling price.

PCs have lower per bit selling prices as well as lower per bit costs compared to other DRAM products. The rise in DRAM production was the result of Micron’s new supply agreement with Inotera Memories, which requires the former to purchase all of Inotera’s manufacturing output beginning 2013 as opposed to half of Inotera’s output as per the earlier agreement. (Read: Micron’s Earnings Confirm That Market Dynamics Are Improving)

In 2008, Micron entered into a joint venture with Nanya Technology and acquired a 35.6% stake in Inotera for $400 million in cash. As per the old agreement, both companies were to acquire one half of the total manufacturing capacity of Inotera, a leading Taiwanese DRAM computing memory manufacturer with a total capacity of approximately 120,000 wafer starts per month. Micron and Nanya continue to be majority shareholders in Inotera with 40% and 29% market shares, respectively.

The renewed agreement with Inotera provides Micron with a greater scale in the DRAM market and will lower its operating expense per wafer. Inotera is known to have cost competitive operations and greater access to the same can provide Micron with stable gross margins in the future. Though Inotera specializes in manufacturing PC DRAM products, it continues to work towards providing a diverse DRAM product portfolio which we believe will help Micron cater to the rising DRAM demand in the memory market.

See our complete analysis for Micron here

As per the new supply agreement, Nanya will reduce its purchases of DRAM products from Inotera to 5% of total production during 2013 and end the purchases completely in 2014. Micron will provide Nanya with a royalty-bearing technology license. The agreement also changes the price mechanism to market-based prices instead of the margin-sharing arrangement in the initial agreement.

Additional Scale Will Help Leverage Growing DRAM Demand

The slowdown in PC shipments, combined with intense competition and macro headwinds, has put the DRAM market in oversupply. However, with increasing consolidation in the industry and rising demand from alternate markets, the industry dynamics have started improving, as is evident from Micron’s Q2 2013 earnings.

While smartphones and tablets are starting to account for an increasing proportion of DRAM sales, PCs continue to have the majority contribution in global DRAM sales. Rising contribution from alternate markets including mobile, tablets, servers, automation and networking contribute to higher DRAM shipments both via rising volumes as well as increasing content in these devices. We believe a shift from PCs to alternate growth segments will help drive demand as well as stabilize declining DRAM prices in the future.

Micron claims that currently 35% and 17% of the bits produced in DRAM are consumed by PCs and networking markets respectively. ^{[1] [2]}

Though a majority of Inotera’s manufactured DRAM products are for the PC market, it is also focusing on providing diverse DRAM products to cater to customers’ growing needs for premium DRAM products for server, mobile, consumer and networking applications. Thus, we believe that increased production from Inotera can help Micron leverage future growth in a variety of DRAM markets. Additionally, according to a UEN report, Micron may move production of 20 memory chip items to Inotera, enabling its factory in Singapore to focus on NAND Flash production. ^[3]

Higher Production From Inotera Leads To A Decline In Average DRAM Selling Price

One of the drawbacks of higher production from Inotera was the sequential decline in DRAM’s average selling price (ASP) last quarter due to higher concentration of sales in the PC market. The average industry DRAM prices have already been declining due to the demand-supply mismatch in the DRAM market which in turn erode Micron’s gross margins for its DRAM business. However, Micron’s claims that its quarter-to-date ASPs for DRAM are up a few percentage points whereas its projected bit costs are down mid-to-high single digits.

While the initial slug of additional capacity from Inotera is from the PC market, Micron intends to move more of that capacity into value-added segments in the future. Thus, the company believes that while in the short-term higher Inotera production negatively impacts any increase in DRAM ASPs, it will contribute solidly to profitability in the long term.

Our price estimate of $8.61 for Micron Technology is at a slight discount to the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Micron Technology’s Management Presents At Wedbush Technology, Media, telecommunication Management Access Conference (Transcript), Seeking Alpha, March 6, 2013 [↩]
2. Micron Technology’s CEO Discusses F2Q13 Results – Earnings Call Transcript, Seeking Alpha, March 21, 2013 [↩]
3. Nanya ends DRAM technology research program with Micron, Focus Taiwan, January 18, 2013 [↩]