The memory chip makers have been slaughtered throughout 2008, suffering from the lack of demand that is fueling slow sales and poor margins. This observation seems to be paralleling the whole semiconductor industry that has slowed during a year of economic turmoil, however, this subgroup seems to be worse off than almost any other. The whole group of memory chip makers has been struggling to record profits as end markets are flush with products, driving down chip prices quarter after quarter. Naturally, an indicator of profitability and solid financial health for this sub-sector is the demand for the end products that utilize such components. With the current recession at hand, PC markets are finding it difficult to sell their product. The question now is how will these corporations do in 2009?
Basic Economics
The magnitude of supply and lack of demand has left chip makers with their hands tied, offering low prices since their products have saturated end markets without any major movement to assuage such conditions. 2008 was a rough year, massive unemployment and the lack of disposable income left electronic producers holding larger inventories and cutting back on production. Mircon (MU: 2.59, 0.00 (0.00%)), the only US company left in the memory space, specifically within the DRAM industry, reported losses mounting over $700 million. This translated to $0.91 per share. Although they did post a loss a year earlier, the key concern with Micron was a decline in gross margins from 0.3% to -32%, showing that the company sold their chips at a loss. The decline in margins are expected to hit semiconductor entities worldwide, even giant Intel (INTC: 14.23, 0.00 (0.00%)) who was downgraded in November by Goldman due to margin pressures. This is a key indicator to the health of this sub sector, a decline is a cause for concern possibly due to the lack of strong demand or excess supply. Going to the other side of the world, the Asian players in the chip market are suffering far worse that Mircon, getting capital infusions much like how Qimonda AG (IQ: 0.00, N/A (N/A)) received from it’s Korean bank partners. Cost saving exercises are also taking place with layoffs, plant sell-offs, and shutdowns. These steps go along with executives taking a cut in pay. So 2008 was bad and shows no signs of improving going into 2009, what will happen to the chip manufacturers?
Turbulence in 2009
I view 2009 as a very turbulent time for the cash strapped chip makers. Q1 and Q2 will be very similar, where margins will continue to shrink and losses will mount. Big name semis will also join the margin crunch and experience declining stock prices, as the economy finds a bottom, semis and the niche memory makers will find one too. Consumer confidence must return so that end markets will consume the excess supply of products using chips and boost demand for computing chips. As these smaller companies see falling stock prices and require help as they burn cash, do not be surprised to see small acquisitions or mergers occur. Do not expect anything large scale to take place, but we can see from the latest capital infusion at Qimonda and the $21 million debt offering from Charter Communications (CHTR: 0.11, 0.00 (0.00%)) amongst others seem to support this idea. With PC and mobile-phone sales predicted to drop by 4%-6%, analysts are becoming bearish and predicting steeper declines, a dismal sign for the semiconductors. I believe that Q3 should signal a slow turn for these distressed businesses as consumers begin spending slowly setting supply and demand back into more favorable terms for the chip makers. Memory makers have struggled through this, those that do not go under or find suitors will perform well in a bull market, performing in a leaner, less competitive environment. 2009 should be crucial for memory makers as the markets rebound, signaling an imminent recovery by the economy. We can only hope for such terms to allow chip makers to return to profitability.
- Santosh Sankar
Disclosure: The mutual fund the author is associated with is long INTC and GS.
