Samsung's second front

Most generals would try to avoid warfare on a second front, the diversion of resources and focus are often lethal. But sometimes when the opportunity presents itself you need to take it. Could Samsung - whilst they are currently battling Apple - be about to open up a second front; this time on Intel? This is the argument for doing so.

Suffering from memory loss

The memory business is maturing fast. PC growth is over & the industry must adjust to a different set of dynamics. Capex has been reduced this year and will be cut further in 2013. The supply base is starting to consolidate. Samsung will still be the king of memory when we have moved into the next phase but once there they will be forced to look at other sectors for continued growth.

Samsung have developed burgeoning logic and foundry businesses in recent years. They are already a force in this arena and one of the real threats to TSMC. That said they will likely lose part or all of their Apple A6 business next year and although will have lined up some new customers in 2013, this must still be a concern.

So memory is maturing and will need less capital going forward. The foundry and logic business is doing well but competition is going to increase. So where does Samsung go next? Where else, but to the money! To the last remaining large profit pool in the industry. To Intel.

This is not a new idea, there has been plenty industry chatter that Samsung could make this move, initially into server CPU and then potentially the PC. It would however require a monumental effort not just to develop the products but also to bring the server industry along with them in adopting the ARM architecture in the mainstream. That said, toppling Intel is never going to be easy.

We never saw that one coming

When Andy Grove and Intel made the decision to leave the DRAM business and focus on CPU's for the then nascent PC business, they gave birth to the industry's original 800lb gorilla. Through their masterful control of the PC platform (with Microsoft) they rode the phenomenal growth for over 25years, became a virtual monopoly and delivered staggering returns.

But the PC growth story is over. And like most monopolies before them, Intel became too inward focused, with the result that they totally missed the Smart Phone and Tablet revolution. 

It is debatable whether or not Intel will make inroads against ARM. But what is not debatable is that they will never dominate Smart Phone and Tablet like they did the PC and therefore cannot deliver the 60%+ gross margin's the company and it shareholders have grown to depend on. So in effect the Intel we all know is finished. The huge margins, the control, even the swagger; it's gone.

Intel warned investors earlier this month that Q3 revenue was going to miss expectations. These things happen you say, so not necessarily a big deal? But what surprises me most about this miss is that they've managed to put if off for so long. And now that it has happened you would suspect it is going to happen with more regularity as long as PC sales continue to fall.

The cure is worse than the disease

To have any hope of re-igniting PC sales again the industry needs to deliver on both price reductions and innovation. But the Ultrabook debacle this year would have to worry you on both counts.

It should have been one of the hot products this holiday season, a combination of sleek design and an attractive price-point would have taken share of mind (and wallet) of many consumers. Instead the PC makers effectively dropped it in Q2 because they couldn't make the numbers work. Many have played the blame game since but you can trust that the key reason the UItrabook has failed to deliver this year is because Intel was looking to keep too much profit for itself. So if Intel cannot be trusted to do the 'right thing' ahead of protecting their historical margins, then I am struggling to understand how they expect to get PC numbers out of reverse in 2013.

One other thing to consider is that despite the huge profits Intel have garnered over the past 25 years, they are not exactly in a bulletproof financial position. Look at this simple analysis of their balance sheet. By necessity the Intel model has required gigantic capex every year to keep building those fabs and maintaining their technology leadership. A couple of years of over-investment here and you could really do some damage.

Kick him when he's down

Intel are vulnerable, more than they have ever been since they exited the DRAM business in 1985. Once they finally accept that their world has changed forever they will then be consumed with the massive re-structuring and re-focusing that implies.

Samsung needs to seize the moment, by mounting a concerted assault on the Server CPU market, promoting and helping to enable the ARM architecture across the industry. The strategy should not be just to take a small slice of the market but to go after Intel and to do some real damage. The PC CPU may follow in the second phase but Server must be first up and kick-off by 2014.

Samsung Semiconductor's achievements in the past 20 years have been close to those of Intel's. When you consider where they have come from and the fact they have essentially cornered the entire memory market's profits for over a decade. They have pre-empted, adapted & excelled at all the changes the industry has thrown at them in the past 10 years. Intel on the other hand has pretty much missed them all but has been protected by it's virtual monopoly position in PC & Server.

Many years ago Samsung management distilled the semiconductor business down to two key ingredients; capital & timing. If they want to take on Intel and become the #1 semiconductor company by the end of the decade, they need to be bold and act now. Even if they have to open up a second front to do so.

Rumours were rife recently of a Seagate buyout of OCZ - nothing happened. But are Seagate even looking in the right places when it comes to SSD?

The HDD makers are flying high these days, primarily as a result of industry consolidation and the supply constraints following the Thailand floods last October. 

The cloud building phenomenon continues globally and here there is nothing to threaten HDD as the choice for primary storage. 

PC RIP
However the story is very different when we look at the PC. There will be approx 350 million PC's built this year (depending on who's numbers you follow) the same number built in 2010 and 2011. If you believe the recent pronouncements from IDC the PC will see 7% CAGR from 2013~2016. But all industry analysts have, for whatever reason, been badly over-estimating PC sales in recent years. Personally I believe that PC growth is already over & the value of any arguments against are an exercise in wasting time. 

This is a huge issue for the HDD makers, as today 50~60% of their units comes directly from the PC. But not only is the top line number going to hurt them but they are also being attacked from below, as SSD has established a decent foothold this year and will only grow from here.

Like arguments about PC growth, the argument about HDD v SSD cost per GB is increasingly redundant. SSD offers speed and performance, which are much more valuable commodities today than extra storage. If you need lots of storage then you have an external HDD for that, or increasingly, the cloud. But don't clog up your PC with it. I thought Marissa Myer's recent memo to staff at Yahoo! said all that needs to be said about SSD.

Granted Seagate and WD/Hitachi can and do participate in the Enterprise SSD market. Although offering circa 10% of total SSD units, it does contribute 30~35% on total SSD revenues. But this sector too will simplify and consolidate in time & the pendulum will swing back to the NAND manufacturers.

We're gonna need a bigger boat
So, do Seagate (or WD) eventually decide to exit the PC & focus entirely on the cloud and enterprise markets alone? Or do they want to remain the kings of storage? If they do, they will need to build their own NAND. If so, I believe the timing might be right.

The current combination of soaring profits and a high share price  enables Seagate to look something a lot bigger than OCZ - Micron. And by early next year the price is likely to be a lot lower than Micron's $6bn market cap today.

Micron are close to sealing their own takeover of Elpida which will help consolidate the DRAM market similar to the HDD market today. However even though I believe this is a good deal, I think the timing might not be. 

DRAM pricing is heading back down again, the victim of sluggish PC demand. Today's prices are already too low to sustain continued investment, so the prospect of lower prices thru next year are going to cause a lot of damage. The rush to find homes for DRAM outside the PC has also taken it's toll and although mobile DRAM still provides good growth, increased competition has driven margins down fast.

So a window may open for a suitable investor in Micron, Seagate should watch closely. It does not have to be an outright takeover, a merger or some form of partnership could also work. They could also consider buying out Intel's remaining share of IMFT as a starting point. Sandisk could also be an option but you could rule that out because a) it is too expensive b) they partner with Toshiba.

Doing such a deal would not only re-open the PC market to Seagate but allow them to participate in the Tablet and Smart Phone for the first time. It would also be of great value to their Enterprise SSD business.

Buying a third party like OCZ, or more established enterprise players like Fusion IO, Smart or STEC fails to address the critical question of How can you be a strategic player in the client SSD market of today and the Enterprise SSD market of tomorrow without having your own NAND? The answer? You can't! 

Seagate have money burning a hole in their pocket right now & pressure from the market to make some bold moves on SSD. But they would be better advised to select the correct target and move when the timing is right. I think Micron might fit the bill in 2013.

Boring Boring DRAM

George would be right at home in the DRAM business these days. 


The DRAM companies have been enjoying a steady increase in monthly contract pricing so far in 2012. But that run came to a halt in June, as Tier 1 PC makers are expected to hold the price flat (avg. $21.50 for 4GB).

Disappointing PC sales in Q2, an increase in their DRAM inventories and less concern about the Elpida situation, has meant the top PC makers are now in a better position to resist the DRAM maker's demands.

Contract prices are likely to remain flat at best in July, after the PC makers have completed their Back to School builds and much of the Windows 8 build ahead. But assuming we see no shocks on the supply-side, then it is likely the contract price may begin to fall after that.

If we do see decreases, don't expect too much though. PC DRAM is in little danger of slipping into a significant over-supply, so contract pricing it is still likely to trade within a narrow band for the rest of the year i.e. 4GB DDR3 $23~$17 (very narrow in the context of DRAM's history).

The spot and after-markets, which has been operating at a near 10% discount to the contract so far this year, are likely to continue to do so in the 2H, or at least until there is any significant change in the Elpida situation. Demand in the local System Integrator and upgrade channels has been abysmal for nearly 9 months now & there is no prospect of relief in the short term.

In the past when DRAM prices where at such low points in the cycle and when they accounted for less than  5% of the PC BOM, this always spurred on MB growth and following that the price rebounded. But nowadays there is no need nor appetite for increasing mainstream PC DRAM content.

It's all a bit of a sorry state of affairs. DRAM used to be the most dynamic sector of the semiconductor business, its 'wild west'. Whereas nowadays it is becoming so predictable and boring it's more 'west country' than 'wild west'.

So DRAM is boring right now, big deal. The interesting thing is though the relative predictability we see on DRAM (and NAND) this year is masking something very big that is coming behind it. The memory business is going thru a serious structural change that will re-shape it & it's participants for the remainder of the decade. Some memory makers have already recognised this and are changing their models successfully, others are paying mere lip service to it, in the hope that the usual cycles will return - most of these guys will be gone by 2020.

Haiku on Micron's takeover of Elpida

                                                               

                       

                                                                      reckoning arrives
                                     the future is still ahead
                                            namhan stirs

Crucial no more?

But does it really matter any more?

Micron have been keen to let investors know how little they depend on the commodity PC DRAM business. Today it accounts for approximately one third of their total revenues, which, in fairness, is no mean feat.

So why, when you are executing such a strategy, would you maintain a significant brand and presence in the aftermarket & channel with Crucial (and indeed Lexar)? If the PC market is dying a slow death, then the aftermarket is already six feet under.


With barriers to entry negligible, Crucial and Lexar face relentless global competition in a technologically commoditised market. On top of that they have to contend with some very strong operators like Kingston and Sandisk, which they have no realistic hope of ever catching.

Meh

The last two iterations of Moore's Law have created a memory surplus in DRAM and particularly NAND, which we are still trying to figure out how to utilise, at least in the PC and consumer space (although the Smartphone & Compute sectors will clear this up soon).
But still, when you can buy a 16GB micro SD for $10 and a 4GB DDR3 module for $20, you have to ask yourself, where do we go from here? The price elasticity that was so predictable and reliable for the sector of industry a decade ago has disappeared.


You could argue that, "developing market" demand will more than replace the drop off "developed markets" but this is too glib. With the likes of ZTE and Huawei already taking the smartphone towards the mass market in China & with low end tablets likely to eat into PC demand, it is folly to assume that historical trends will be a good indicator to the future aftermarket demand.


Getting back to Micron, the resources involved in maintaining Crucial/Lexar are not inconsiderable. The staff, the facilities, the marketing, the distribution partners, the cash flow, the sheer focus and time it must take up. It may provide Micron with some nice ASP's on paper but I don't believe the means come even close to justifying the ends.

Make your way to the exit please

Simply put, they should get the hell out of this business. It should be sold to one of the strong aftermarket players. Micron could potentially cut such a deal on good terms this year. We have already posted about the issues facing the big module houses with the demise of Elpida. With these guys now scrambling to secure similarily favourable DRAM supply elsewhere, an opportunity to bundle Crucial/Lexar along with this exists.


If Micron did takeover some or all of Elpida, they would immediately have this extra capacity to offer Kingston et al and could probably get $200~$300M offloading Crucial/Lexar as part of the deal too. But even without the Elpida takeover Micron need to have an exit strategy. I am not arguing that the aftermarket and channel will disappear overnight, only that DIY is not the most efficient way to approach it.


There was a time when establishing a presence in the aftermarket was a logical step. Many memory makers looked at Kingston & their profits and thought, 'we'll have some of that.' But very few have ever succeeding in doing so. Most have found that the cost advantage they have in terms of captive supply & IP is regularly given away in order to take market share, and often your channel is used as an easy dumping ground for problems elsewhere in the business. Lesson - leave the aftermarket to the experts and focus on your own core strengths.


On many levels Micron have done a remarkable job in the past 5 years, consolidating the DRAM supply base, rapidly lessening their dependance on the PC & not least striking up some really significant and successful JV's. So why are they still concerned about a dead market? Do yourself and your investors a favour and head for the exits.

Please feel free to post any comments below.


If you want to discuss anything in more detail please email me at memoryman@notsodimm.com