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The Downs (and Ups) of the DRAM Market

The good news is that it's going to get better. The bad news is that it's going to get worse first. That pretty much sums up the price swings in the market for the commodity computer memory chips known as Dynamic Random Access Memory, or DRAM. These chips are used mostly in PCs, but also in a host of other devices from phones to cars. And the fallout will be felt by chip- and computer makers across the globe for months to come.

Take Micron Technology (MU), which on Apr. 10 reported a profit of $193 million on sales of $1.23 billion in the period ended Mar. 2. The Boise-based company gets about 80% of its sales from DRAM, so it's particularly sensitive to shifts in supply and demand. Historically, the first and second quarters are tough for DRAM chip suppliers because demand drops, unsold chips remain in the inventory pipeline, and prices slump correspondingly.

But this year was different. Chipmakers slowed their first-quarter production, stabilizing prices in a period when they tend to weaken. Micron executives and analysts alike have said DRAM prices held up well in the early months of the year. "Industry DRAM pricing was generally better than our expectations," JP Morgan analyst Shawn Webster wrote in an Apr. 18 research note.

SUMMER WARMING. So far, so good, right? Wait till the second calendar quarter, says iSuppli analyst Nam Kim. "The price decline will be much steeper than usual," he says. While the average price for a 512-megabit memory chip was $5.68 during the first quarter, it's expected to drop by 80-or-more cents a chip or more in the second quarter. In an industry where chips are sold in lots of 10,000 and constitute a $26 billion global market, the financial swing for a DRAM maker like Micron, Germany's Infineon (IFX), or Samsung and Hynix in South Korea can be violent.

And so it will be for the rest of the first half, Kim says. Demand will drop into its usual lull in the second quarter and production increases from companies like Japan's Elpida and Infineon will boost supplies. Contract prices -- the prices chipmakers charge PC makers like Dell (DELL), Gateway (GTW), Hewlett-Packard (HPQ), and Apple (AAPL) -- which surged in January and February, will begin to settle back down.

But toward the end of the second quarter, prices should start to improve heading into the summer months. Demand for DRAM tends to rise in the third quarter and into the fourth, as PC vendors ramp up production in anticipation of the back-to-school season, followed by the holiday season. That expectation has improved the outlook for Micron in particular. JP Morgan's Webster raised his outlook on Micron to neutral. "We believe stable/improving pricing increases the potential for gross margin expansion at Micron," Webster wrote in his note.

NAND ADVANTAGE. What's behind the first quarter's stability and expectations for higher prices later in the year? It's partly a function of tighter supply, as chipmakers shift into another kind of memory, so-called NAND flash. Over the summer, memory-chip makers caught some kind of fever for NAND chips -- the type used in products such as Apple's iPod nano and similar MP3 players.

Apple made headlines for cutting exclusive supply deals with Samsung (see BW Online, 8/26/05, "A Memorable Deal for Apple and Samsung?"). It went on to strike similar deals with Micron and Hynix. Micron even went so far as to create a joint venture with Intel (INTC) focused on NAND production (see BW Online, 11/22/05, "Intel Switches Its Chip Bets").

While constituting a smaller market -- about $13 billion worldwide -- and costing about a third as much to make as DRAM chips, NAND chips generally have better profit margins than DRAM, according to iSuppli's Kim. So many companies DRAM suppliers have converted some of their production capacity to NAND. That caused a supply glut in NAND chips in the first quarter that's going to take some time to work through the supply chain, while prices have fallen by nearly 20% since the first quarter. Samsung and Hynix have even started to switch some of their production capacity back from NAND to DRAM in response to the oversupply.

KOREAN GIANTS. The good news is that the choppy waters of the second quarter aren't seen as severe enough to change the otherwise optimistic outlook for the remainder of the year. Merrill Lynch analyst Joe Osha, in a note published the week of Apr. 11, forecast a 16% compound annual growth rate in DRAM sales for three-year period starting 2006. Osha says the South Korean chipmakers, which combined account for about 40% of the world's DRAM supply, are still favoring NAND production -- and its better margins -- over the long term, and as a result are keeping a tight rein on plans to build more DRAM chips.

That's going to boost DRAM prices through the end of this year. "What you have to note is that the world's three largest DRAM makers [Samsung, Hynix, and Micron] are all making NAND flash chips as well, and the focus in production growth, particularly by Hynix and Micron, is on NAND chips," says Jeon Jun Young, a vice-president at Samsung Electronics. "This leads to a tight supply in DRAM. A sharp fall in NAND prices could lead to a temporary fall in profitability but will result in growth in demand, as more and more gadgets will use flash chips at greater capacity. We believe it's a healthy development."

James Kim, a Hynix vice-president, esays the company hopes to increase its sales by about 20% this year, from $5.78 billion in 2005. And he expects Hynix's profit margin to stay the same or drop slightly from last year's 27%.

MEMORY LOSS. iSuppli analyst Nam Kim says he expects those companies with a greater exposure to the NAND market -- particularly Samsung and Hynix -- to be at a slight disadvantage. "While the shipment growth for NAND is generally faster than DRAM, the prices are falling fast," he says. "With prices falling so much, buyers will want to stock up in the slower second quarter and rebuild inventory they depleted in the first quarter."

Still, with all the volatility, some giant chipmakers want to distance themselves from memory altogether. Germany's Infineon, for instance, plans to spin out its memory chip unit on May 1 into a 100%-owned subsidy called Qimonda, in part to isolate the rest of its business from the sector's unpredictable ebbs and flows. Infineon, the world's No. 2 maker of DRAM chips by volume and No. 4 by revenue, is trying to move into specialty memory products. It's due to report quarterly results on Apr. 26. Seems like everyone's looking to see where the chips will fall.

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