Micron Technology (NASDAQ:MU), the only major U.S.-based manufacturer of memory products, is in the final stages to acquire Elpida Memory, a leading mobile DRAM manufacturer. Micron agreed to acquire 100% equity in Elpida for $2.5 billion in July 2012, after the latter applied for a corporate restructuring. While $750 million will be paid in cash at the closing of the transaction, $1.75 billion will be payed in future annual installments through 2019, from the cash flows generated from Micron’s payment for foundry services provided by Elpida as its subsidiary. Micron is slated to save approximately $400 million on the total transaction due to the current slump in Japanese yen against the dollar. 
The DRAM market is currently suffering from a demand-supply mismatch and declining selling prices, which has severely constrained industry profits. However, judging by Micron’s Q2 2013 earnings release, it looks like the memory market fundamentals are improving. Better macro conditions is raising demand while increasing market consolidation has reduced the excess manufacturing capacity.
With Elpida on board, Micron is slated to become the second largest DRAM manufacturer after market leader Samsung (SSNLF). We believe that a correction in DRAM supply and rising demand from alternate markets will help drive DRAM shipments in the future. Benefiting from greater economies of scale, we think Micron will witness higher revenue growth and better financial results in the future.
Improving Market Dynamics to Fuel DRAM Shipments
The memory market is highly cyclical in nature and is currently seeing excess supply and declining average selling prices (ASP). The increasing number of manufactures in the market combined with declining global PC shipments impact the DRAM demand-supply dynamics, which in turn put pressure on DRAM ASPs. PCs have traditionally been the major buyers of DRAM and a slowdown in the PC market has considerably impacted demand for DRAM products.
However, with its inventory declining by more than $350 million y-o-y over the past 12 months, Micron claims that the supply dynamics in the memory market (both DRAM and NAND) are improving. Here are some of the factors that reiterate our belief that the positive trend will continue in the future as well.
- Increasing consolidation in the DRAM market: DRAM manufacturing is highly capital intensive, and as the technology nodes shrink, the costs of setting up a fabrication unit keeps increasing. The business is such that there is no customer loyalty or brand recognition, and hence it is tough for smaller players to survive. While many of its competitors have had to sell out or shut down operations due to mounting losses, Micron has managed to hold its ground well. The ongoing consolidation in the DRAM industry has taken some excess capacity off the market. A correction in supply along with improving demand will help existing DRAM players return to profitability in the future.
- Demand from alternate markets to fuel DRAM shipments: The DRAM industry is witnessing a shift in market capacity, away from PCs to higher growth segments such as mobile and servers. While PCs continue to account for the majority of global DRAM sales, rising contribution of 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. Research firm iSuppli forecasts the combined share of mobile handsets and tablets in the DRAM market, to reach 26.7% by the end of 2013, almost double from 14.1% in Q1 2012. 
We believe a shift from PCs to alternate growth segments will help drive demand as well as stabilize declining DRAM prices in the future. Staying in line with changing trends, Micron intends to shift its focus on specialty markets such as server, networking, graphics and consumer devices.
Micron To Become The Second Largest DRAM Player
With Elpida’s acquisition, Micron is expected to overtake Hynix to become the second largest DRAM chips manufacturer behind market leader Samsung.
- Increasing Manufacturing Capacity: Elpida’s assets include a 65% ownership in Rexchip Electronic Corp. Apart from Elpida, Micron also agreed to buy Powerchip Technology Corporation’s 24% share in Rexchip for approximately $334 million. The fab assets acquired from Elpida and Rexchip will increase Micron’s current manufacturing capacity by almost 50%.  Micron currently has two fabs dedicated to DRAM production, but with Elpida’s acquisition the number of fabs will double. The company has the flexibility to shift production capacity between NAND and DRAM products, enabling it to take advantage of changing market conditions.
The memory market is expected to increase its installed capacity by 8.2% by the end of 2013.  In 2012, Micron was at the fifth position in terms of installed capacity, but with increased production capacity, it is expected to have the second largest installed capacity by the end of this year.
Source: IC Insights
- Higher Mobile DRAM Penetration – While Micron is known to provide enterprise DRAM solutions for networking and servers, Elpida has a strong presence in the mobile DRAM market. Micron currently generates less than 10% of its revenue from mobile DRAM, but with Elpida on board, the proportion can significantly increase in the future.
- Increasing Exposure To Apple: In addition to getting a hold of Elpida’s market share, Micron will have the added advantage of supplying chips to Apple (NASDAQ:AAPL), which could further boost its DRAM market share. Elpida currently supplies SDRAM for Apple iPhone 5. In June 2012, Apple placed a new order for DRAM chips with Elpida cutting its reliance on rival Samsung for component supplies. Elpida currently has 1,000 patents in its portfolio. If Micron is able to better leverage Elpida’s patent portfolio it can increase its business with Apple and other players, significantly accelerating its growth rate in the future.
Our price estimate of $8.61 for Micron Technology is at a slight discount to the current market price.Notes:
- Elpida Memory: Micron Poised to Save $400MM in Acquisition, Solid State Technology, April 29, 2013 [↩]
- Sign of the Times: PC Share of DRAM Market Dips Below 50 Percent for First Time, iSuppli, September 14, 2012 [↩]
- Micron and Elpida Announce Sponsor Agreement, Micron Press Release, July 2, 2012 [↩]
- Acquisition Of Elpida Memory Inc. By Micron Technology, Seeking Alpha, April 2, 2013 [↩]