DRAM THE TORPEDOES
What is the value of Hynix? The answer won't be found in its Micron merger negotiations.
By Jasper Moiseiwitsch

As of mid-January, Hynix, a heavily indebted Korean chip manufacturer, was at the late-round stages of negotiating some form of "strategic alliance" with Micron, an American competitor. News reports daily predicted some sort of deal announcement, with most expecting that Micron would buy part or all of Hynix's core Dram operations. But for all the build-up, discussions were stuck on price, with the media speculating that Micron was offering about half what Hynix wanted. Wherever the Hynix-Micron negotiations go, it is worth exploring how two sides can differ by billions in their valuations.

The Hynix View

To understand how much Hynix thinks it is worth, get into the heads of its creditors. Last autumn these parties agreed to trade US$2.4 billion in Hynix debt for bonds convertible into about 45 percent of the firm's equity. So, on a strictly proportional basis, creditors should now be comfortable with a figure of US$5.2 billion for Hynix all-in.

There is also another way to look at it. Micron has a shareholders' equity value of US$6.9 billion. Its sales account for about 22 percent of the global Dram market, while Hynix's comprise 17 percent. So on a strict like-for-like basis Hynix might figure that their Dram fabs would be worth about US$5.3 billion to Micron.

And then the Hynix negotiators would be undoubtedly encouraged by where they are at in the chip cycle. Dram prices are rising. Hynix reported in January that it raised contract prices on its Dram chips by an average of 30 percent. This Dram recovery is fuelled in part by increasing demand for PC memory - demand created by the launch of the memory hungry Windows XP operating system and a new Intel double-data rate chip set, which has required production of a new type of DDR-ready memory chip.

But if the chip market is rousing from last year's slumber, this can complicate as well as help Hynix in their Micron talks. First, there are concerns that this might be a false rally. That, after the Christmas rush, demand for PCs might slump again. Second, the start of a bull cycle would put immediate capex demands on Hynix at a time when it can ill afford such expenditure (about US$900 million for 2002, says CSFB).

To position itself the company would need to raise more money. But the debt-impaired Hynix has a higher cost of capital than its competitors, and has so thoroughly tapped markets in past months that sheer courtesy demands that it stay away for awhile.

The Micron View

Which suggests that a Micron deal of some form would make sense. But media reports say that the Micron offers are coming in at the low end. Jonathan Dutton, a Seoul-based technology analyst for UBS Warburg, estimates that Micron is looking to pay no more than one-time Dram sales, or about US$2.3 billion.

One-times sales is a low figure for any company in any industry, and would completely discount all the pain, write-offs and risk that Hynix backers have endured over past years. But then Hynix is a spectacular underperformer, even by the dismal standard of the memory sector. It lost money four of the past five years (and a hefty US$2.8 billion for the first three quarters of 2001). With these bleak figures in mind, last autumn, the Hynix audit committee valued its assets at 25 cents on the dollar.

And all evidence suggests that Micron is looking to pay less than retail. Indeed, purchasing Hynix puts the Idaho-based company on a familiar track: buying competitors' assets at fire-sale prices at the bottom of the chip cycle. It did so in June 1998, when it bought Texas Instruments' (TI) facilities for US$800 million (and then received US$750 million in financing from TI to upgrade the facilities). And in December 2001 it entered into an MOU with Toshiba to take on the Japanese company's Virginia Dram facility (paying US$250 million and 1.5 million Micron shares).

And now, in its Hynix negotiations, media reports speculate that Micron is negotiating a cut-rate price for the Korean company, partly by asking its creditors to absorb a huge write-off (as much as US$3.8 billion, according to the Asian Wall Journal). This might be too much to bear. Hynix's collection of creditors forgave US$1.1 billion only last November. Their reluctance to take another hit is widely seen as the central sticking point in negotiations. Micron's interest in Hynix is not so much to own their facilities as to contain them. The Dram industry suffers from over-capacity and, although it seems to be going into an upturn, Micron would like to control Hynix's output to bring prices back to a stable, profitable level.

Says Keon Han, technology analyst with Bear Stearns in Hong Kong: "It's a sensitivity analysis sort of thing where Micron says, 'If we knock out X percent of Hynix's assets, how much supply do we reduce globally? And with that supply reduction, how much will chip prices increase, and how does that help the bottom line?'"

So Micron is looking to buy Hynix on the cheap, to give it an option on capacity, to ramp production up or down as supply dictates. Analysts expect Micron to shut some of Hynix's fabs if they take control - CSFB technology analyst Bhavin Shah expects them to shutter three or four facilities, while Han guesses two. How much is a diminished Hynix worth to Micron? Somewhat less than the US$5 billion figures estimated above.

So once again Hynix is involved with an epic markets drama capturing media attention far outweighing its importance. The company had a desperate 2001. It was bailed out twice in the year, with Salomon Smith Barney leading an energetic recapitalization drive that stretched over months and saw the company wring billions out of the market in the form of bonds, convertibles and GDRs. Banks were forced to write off debt and investors lost money but, by the end, everyone seemed amazed by Hynix's survival skills. It is Dram's Tiny Tim, the little chip manufacturer that could.

Jasper Moiseiwitsch is a contributing editor at CFO Asia based in Hong Kong.