CAN the circle be unbroken?
Despite record earnings, the world’s largest memory chipmakers still have to prove that they’ve escaped the boom-and-bust cycles long known to the industry.
This question is all the more relevant, now that South Korea’s SK Hynix Inc is marketing a US$28bil US listing. Its American depositary receipts (ADRs) will begin trading on July 10.
Investor scepticism has been on the rise. After joining the trillion-dollar club, Micron Technology Inc and SK Hynix – the two memory chip pure plays – have been struggling, with their shares displaying elevated volatility.
This has drawn criticism from Michael Burry of The Big Short fame, who disclosed a short position in Micron last week, proclaiming that the company “defines cyclical like no other”.
Shares of Samsung Electronics Co tumbled 8% on Tuesday despite a preliminary earnings beat. It was a sign that one good quarterly report card is not enough to please investors.
The industry is dominated by an oligopoly with Samsung the third largest player.
Dark clouds are gathering. Mega projects launched in South Korea threaten to disrupt the existing cozy competitive landscape.
Meanwhile, aggressive newcomers, notably China’s ChangXin Memory Technologies Inc, or CXMT, could exacerbate a downturn when the cycle shifts.
So, how can the likes of Micron and SK Hynix bulletproof themselves against a future memory meltdown?
The key is long-term agreements, or LTAs. And the hope is that faced with a memory shortage – estimated to persist until 2027 – eager customers are willing to sign contracts that favour the chipmakers.
Micron has given us a blueprint of what these agreements could look like. They typically last five years.
Customers need to put down cash deposits to lock in supply.
And there’s a price range, with a ceiling capped at the prevailing market rate at the signing of the contract, and a floor that provides a gross margin “well above” Micron’s historic peak of 61%. The final selling price is negotiated periodically, but doesn’t go outside the band.
This kind of arrangement flattens out price volatility, the closest thing the industry has to support the claim that it’s entering a supercycle.
Prepayments, which essentially serve as a break fee, make it harder for customers to walk away during a downturn.
Meanwhile, a price floor that’s still profitable to the manufacturer can ensure sustainable earnings until the end of the decade.
But getting these contracts right is tricky. By signing an LTA, manufacturers will almost inevitably have to give up a sizeable chunk of the upside.
After all, an increase in chip prices is the driving force behind record profits.
At Micron, shipments of dynamic random-access memory, rose by only low-single digits in the quarter ending May, while the average sales price shot up by over 60%.
How much bargaining power a chipmaker really has and the earnings potential it’s willing to forego for downside protection is still up for debate.
The timing of LTAs also matters. Suppliers should consider staggering their agreements so they don’t all expire at once, to avoid a situation not unlike what pharmaceuticals have to go through when the patents on their blockbuster drugs expire.
Micron expects that upon completion, the contracts it has signed will account for at least half of its revenue.
And how about communication? In the latest earnings call, Micron delighted Wall Street analysts with details of its strategic customer agreements.
By the same token, SK Hynix will have to be more transparent, too, when it releases earnings later this month, especially since its ADRs will be trading in New York by then and held by non-South Korean investors less familiar with its business operations.
Entering the trillion-dollar club is already a reflection of prestige.
But to stay there and prosper further, the chipmakers need to proactively show that they can escape the circle of life and death they’ve long been used to.
Taking advantage of a supply shortage and signing lucrative customer contracts is a good start. — Bloomberg
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. The views expressed here are the writer’s own.
