Memory-chip manufacturer Micron Technology (NASDAQ:MU) disappointed some investors last week when it announced a $1.2 billion offering of common stock. Not only does this move dilute existing shareholders by introducing new shares into the market, but it can be taken as a sign that management doesn't think its stock is all that cheap.
Micron doesn't exactly need the money. The company produced more than $5 billion of net income in fiscal 2017, and the balance sheet features more than $5 billion of cash. But Micron's business can be brutally cyclical. Exploding prices for DRAM and NAND chips have pushed Micron's profits to record levels this year, but if history is any indication, the party won't last forever. The proceeds of the stock sale will be used to pay down debt; that's a smart move in my book.
Fortifying the balance sheet
Micron's debt load doesn't seem like a big deal, given its recent performance. At the end of fiscal 2017, Micron had about $11 billion in total debt. The company paid $560 million in interest during that year, less than 10% of its operating income. If you looked at fiscal 2017 in a vacuum, the decision to sell stock and pay down debt wouldn't make much sense.
But last year was an outlier, not business as usual. A combination of strong demand and constrained supply has pushed up memory-chip prices over the past year. The story was much different in fiscal 2016, when Micron posted a net loss, with the bottom line ravaged by slumping memory-chip prices. Micron's management knows that the current environment won't last forever, and that $11 billion of debt is a lot harder to deal with during periods of vanishing profits.
Micron's plan is to take advantage of its soaring stock price to raise cash and pay down debt before the memory-chip market turns against it. That way, the next time memory-chip prices tumble, Micron will be in a better position to weather the storm. Shares of Micron are up more than 140% over the past year, sitting around $41. They look cheap relative to current earnings -- analysts expect $7.58 in adjusted earnings per share in fiscal 2018. But remember that average earnings are a different story.
If you're a long-term Micron investor, you should be cheering this move to pay down the debt. If you've held for many years and through multiple cycles, you know that the good times won't last forever, and that racking up too much debt when prices are booming can be a recipe for disaster when things take a turn. This stock sale is a forward-looking move from Micron that benefits long-term investors.
The next downturn
As in any commodity market, accurately predicting pricing in the memory-chip market is mostly a guessing game. The current pricing environment could hold up throughout next year, or it could come to an end much sooner. The result may be a market where prices fall sharply, or a market with more moderate declines. It's simply impossible to say for sure.
Micron's management does see things cooling down next year, although it's optimistic that per-bit costs will fall in tandem with any pricing declines. In Micron's fourth-quarter earnings conference call, CEO Sanjay Mehrotra said he expects a healthy supply-demand balance for both the DRAM and NAND markets in 2018. He elaborated, in response to an analyst question: "Regarding pricing, we don't specifically, for competitive reasons, provide comments on pricing on the call. But we'd just like to point out that we believe that the healthy industry environment is one where price decline is less than or equal to cost decline."
Micron's profits will hold up even if memory-chip prices begin to decline, if the company can cut costs at the same rate. There have been times in the past where it hasn't been able to do that, and those times will come again at some point down the road. Thanks to this $1.2 billion stock sale and the subsequent debt reduction, Micron's balance sheet will be better equipped to handle it.