“MU was our biggest winner in 2014. Unfortunately, we overstayed our welcome and gave back much of those gains this year. The shares peaked at over $36 last December before collapsing to $14.98 on September 30. Our thesis has been that MU’s primary product, DRAM, has consolidated to three players, who are likely to create more industry profits compared to when DRAM production was highly fragmented.
The problem is that structural industry improvement doesn’t make DRAM less cyclical. The large capital requirements force participants to make large investments in anticipation of future demand. If the industry overestimates demand, it still makes sense to operate at full capacity and oversupply ensues. This year, demand came up short, DRAM prices collapsed, and despite our concerns about PC demand, we missed the turn of the cycle. Those PC demand worries led us to sell LAM Research and Marvell Technology at good prices prior to a sell-off in each security and we shorted (and subsequently covered) Best Buy, IBM and Intel. Although all of these moves helped, we underestimated the extent of MU’s exposure to the PC demand shortfall.
MU’s other business is flash memory or NAND. We anticipated a significant recovery in NAND this year that failed to materialize. MU is set to earn far less than we expected, and earnings will remain low until supply and demand come into balance.
Two other problems with our thesis have emerged. First, the Chinese have expressed interest in getting into DRAM. Our prior view was that the consolidated industry would not face new entrants. While the Chinese threat is distant, we judge it relevant. Second, MU announced a much more aggressive capital spending plan for NAND than we envisioned. While management believes that the extra investment will generate adequate returns, we are unconvinced. With separate problems clouding both the short-term and long-term, we determined that there is enough risk to the thesis to reduce the position.
The three large problem positions tell only a part of the portfolio story. The trouble started toward the end of the second quarter. In early June we were up a little for the year, which wasn’t exciting, but we were about even with the market. We had noted it was hard to find things to buy. Then, between June 4 and August 18, we lost more than 14% (41 losing days and 13 winning days) in a flat market. It was a period where cheap stocks got cheaper and expensive stocks became ever dearer.
Notably, we suffered most of our losses prior to the market decline that commenced in late August. As the market fell, our portfolio performed only slightly worse than we would have expected. Our shorts fell almost as much as our longs and we lost only a little more than our net exposure during the correction,” Greenlight said.
Whitney Tilson’s Kase Fund (T2 Partners) held around 181,420 shares of Micron at the end of September, up by 32% on the quarter. The investor did not file a 13F filing for the end of the fourth quarter of 2015. In its third-quarter letter to investors, Tilson said:
‘”I wrote about why I liked Micron in last quarter’s letter, but I was too early, as the stock has fallen another 20%. I don’t think it’s too early anymore and I recently added to our position.
The company reported dismal earnings on Thursday and gave weak guidance for next quarter, yet the stock rose 7.7% on Friday because expectations – and the stock price – were so low. This is the kind of stock I like to own: one that is almost impervious to bad news, but will soar on any hint of good news.
The stock is stupidly cheap at ~4x the company’s potential earnings power in a good environment (which I estimate at $4/share), a 40% discount to the replacement value of its manufacturing facilities, and 24% below a lowball $21 bid by a Chinese state-owned chip design company, Tsinghua Unigroup Ltd.
While short-term demand for DRAM chips is weak and Micron’s costs are elevated due to the need to upgrade its manufacturing plants, the two key pillars of my investment thesis remain intact: 1) continued strong (20%+) underlying growth in long-term demand; and 2) rational industry behavior (i.e., restrained capacity growth), the combination of which should lead to solid pricing and healthy profits over time. Those last two words – “over time” – are important, however, because while the economic characteristics of the industry have improved markedly, it remains cyclical (as we’re seeing now).”
Keeping this in mind, we’re going to take a look at the latest action surrounding Micron Technology, Inc. (NASDAQ:MU).
