It's no secret that the DRAM and NAND flash industries have been in the tank all year courtesy of overcapacity and weakening demand. For the particular parts referenced in the graph below, that's a 71% decline in flash pricing and a 57% decline on the DRAM side.

While the pain associated with these prices has been universal, nowhere has it been more acute than in a handful of Taiwanese DRAM manufacturers and Qimonda ( QIM), the Infineon ( IFX) memory spinout.

Contract Memory Prices
DRAMeXchange

It's obvious from the data through September 30 in the table below that the Taiwanese group is in trouble.

Taiwan Memory Manufacturers
Company Reports

You'd see the same thing from Qimonda, but they haven't even reported their September quarter. DRAM prices are down another 30% to 50% for the December quarter, so the problems will only be magnified further.

The Taiwanese companies do not have a competitive cost structure due to their lagging process technology, hence the very painful gross margins. They have burned through cash and at the same time leveraged their balance sheets. Much of the debt due within a year cannot be paid off with remaining cash nor is there sufficient cash from rations to do the job or finance future capital spending requirements.

Enter the Taiwanese government. While nothing has been made public, there has been much supposition that the government wants these companies consolidated. More important from an investor's perspective, the government wants Micron ( MU) and Elpida (a Japanese company) to play a roll in that process.

Micron already has relationships with Nanya and Inotera courtesy of its acquisition of Qimonda's stake in Inotera and a joint venture ( MeiYa) with Nanya. Elpida is the co-owner of Rexchip, a joint venture with Powerchip, and has acknowledged that it's in discussions with both Powerchip and ProMOS.

The Inotera purchase by Micron was more of a steal than a business transaction. For $400 million and the use of its stack process technology, Micron will get 50% of the 120,000 wafers per month produced at Inotera. The price tag is a small fraction of the cost of adding the capacity when you consider that Qimonda will take a charge on the transaction of approximately $440 million. Can you spell "desperation"?

The remaining ownership of Inotera resides with Nanya, which already had a relationship with Micron. Interestingly, Nanya's supervisory board is controlled by executives of Nan Ya Plastics, and Nan Ya Plastics is controlled by one of the most influential families in Taiwan. When Micron announced the acquisition from Qimonda, a portion of the funding was to be supplied by a "strategic lender" at favorable rates. Now it turns out that lender is Nan Ya Plastics. Hmmm...

So what is likely to happen when the dust settles in Taiwan? The government has two interests: first, maintaining a foothold in the DRAM industry as part of its electronics industry; second, employment. It is a motivated consolidator and can use outsiders to restructure the companies. The five separate entities will likely be pared down to two or three joint ventures with Micron and Elpida. More capacity will be taken offline as production levels are rationalized and processes are brought up to the industry's leading edge. More important, the capital to do all this will likely be provided by the Taiwanese government.

Micron and Elpida will have enhanced their own positions with minimal risk; reduced their cost basis by spreading process R&D costs over a far greater level of output; and reduced industry capacity, thereby enhancing pricing as well. All-in-all, not a bad way to come out of the worst industry downturn in decades.


Know What You Own: Micron operates in the memory chips industry, and some of the other stocks in its field include SanDisk ( SNDK), Rambus ( RMBS), NetLogic Microsystems ( NETL) and Silicon Storage Technology ( SSTI). For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.
At the time of publication, Faulkner was long MU.

Bob Faulkner has been in the investment business for 18 years with an exclusive focus on technology stocks. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Faulkner appreciates your feedback; click here to send him an email.

Interested in more writings by Bob Faulkner? Check out his newsletter, TheStreet.com The Telecom Connection. For more information, click here.

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