Micron's Bottom Line

Oct. 4, 2000 -- Micron Technology reported fourth-quarter earnings of $1.20 a diluted share, trouncing Wall Street’s estimates of 96 cents a share, as sales from semiconductor operations skyrocketed.

While bearish investors anticipating another death knell for the PC industry were licking their chops ahead of today’s report, few close observers of the Boise, Idaho, company were worried about problems with Micron’s bottom line.

That may sound odd, given the recent performance of a market that iscrucial to the company’s success, the market for dynamic randomaccess memory, or DRAM.

Micron makes the overwhelming bulk of its money on DRAM, and DRAM prices have been tanking lately. Prices in the spot DRAM market, in which memory chips are sold for immediate delivery, were already languishing before Intel issued its memorable revenue warning two weeks ago.

Micron Escapes Sector’s ProblemsBy the middle of September, 64-megabit DRAM (the industry benchmark) was trading between $7.50 and $8, well off its spring highs. But things got considerably worse on news of extremely weak demand for Intel’s products in Europe. Because chipsets and motherboards mainly go into the same end market as memory — the PC market — Intel’s troubles quickly spilled over into the spot DRAM market.

Major PC manufacturers that had been hoarding DRAM in anticipation of ayear-end shortage suddenly had no good reason to continue holding thatinventory, and the price of 64-megabit memory tumbled to near $6 asthey unloaded their stock.

Luckily, Micron’s quarter ended in August, before Intel shook up theDRAM market.

“They’ve locked up the quarter a bit ago,” says Jack Geraghty, an analyst at Gerard Klauer Mattison who rates Micron a buy.

What Investors WantMicron investors wanted to hear Chairman and CEO Steven Appleton report that the company is seeing a strong order book going in the current quarter.

Investors hoped to hear that overall demand isn’t as weak as was suggested by Intel’s and Apple’s recent warnings, andthat the favorable supply/demand dynamic most expect 2001 to bringremains intact.

Perhaps most importantly, investors hope Micron can demonstrate confidence that the recent downtrend in spot DRAM will be arrested.

Analysts generally maintain that short-term fluctuations in the spotmarket are irrelevant to Micron’s fortunes. The company gets its revenue not from the spot market, but from contracts that major customers like Dell set in advance, and contract prices for DRAM have lately been hovering about $1 above spot.

Trouble Could Lie AheadBut the longer spot prices stay depressed, the warier investors should get.

“At the EPS level, [the spot market] has no impact,” says Bernstein analyst Vadim Zlotnikov, who rates Micron an outperform and whose firm hasn’t done any underwriting for the company. “But in the medium term, if you have spot going down during a seasonally strong fourth quarter, that’s surprising. It causes people to extrapolate. The gap between spot and contract never stays wide for too long.”

PC manufacturers can renegotiate the terms of contracts when industry conditions warrant.

Micron doesn’t need a major spike in DRAM to increase its earnings.

The amount of DRAM manufacturers stuff in PCs has historically tendedto rise about 10 percent per quarter. And because the size of chips iscontinually shrinking, thus increasing the number of chips that can beproduced from a wafer of a given size, manufacturers manage tocontinually lower production costs.

A mere stabilization of DRAM prices could be good enough to smooth things over.

“They’d do very well if [contract] prices stabilize here in mid-$7 to $8 range,” says SG Cowen analyst Rick Billy, who rates Micron a buy, his firm’s second-highest rating. “They’d just coin money.” (SG Cowen has not underwritten Micron.)

Still Stable Investment?But there are a number of reasons why Micron might not be coiningmoney. PC manufacturers may still have significant DRAM inventoriesthat have yet to make their way to the spot market. DRAM-per-PCgrowth could slow. The weakness in PC demand could get much, muchworse.

But the downside risk in Micron is considerably less than it was just ashort while ago. Without having verbalized any caution on its revenue or earnings outlook, the company has lost more than 50 percent of its market value since late August.

That whipping has made Micron one of the cheaper semiconductor plays around, the stock having closed Tuesday at $43.06 — about 19 times estimated 2000 earnings, according to First Call, and just nine times what the company is expected to earn in 2001. Today’s earnings were reported after the market closed.

SG Cowen’s Billy believes that if other key data points stay positive, PC growth would have to collapse to make a big difference for Micron. “Ten percent unit growth would be sufficient,” he says. “No unit growth would be a problem.”