Advice to SMIC: Stay Away From Elpida 中芯国际应远离尔必达

By newsdoug on May 3, 2012

SMIC considering Elpida assets? I’ll admit that I secretly am cheering for a successful turnaround at SMIC (HKEx: 981; NYSE: SMI), a perennial underdog to its better-run Taiwanese rivals, which is why I’m a bit disappointed at the latest reports that say that China’s top chipmaker is considering a bid to buy some operations from bankrupt Japanese DRAM maker Elpida. Of course there’s a chance that the news, which was reported in Japanese media, isn’t true, which would be a relief as this purchase makes little or no sense in my view. But I suspect there may be some truth to the news, which would be a big mistake for SMIC if it succeeded in such a purchase. Let’s take a look at the actual news, which says that Hony Capital, a major Chinese high-tech private equity firm, wants to buy the bankrupt Elpida, and then would sell one of Elpida’s DRAM plants in Hisroshima to SMIC. (English article; Chinese article) The report also says one other plan being discussed would have SMIC come in and simply operate the plant, while Hony would presumably remain the owner. This latest report follows another one last month, when Japanese media first broke the news that Hony and US private equity firm TPG were teaming up to make a bid for Elpida, which declared bankruptcy earlier this year following years of losses in the ultra competitive global memory chip market. (previous post) What’s new in this latest report is the inclusion of SMIC in this potential buyout plan. For those who don’t follow SMIC that closely, the company was launched more than a decade ago with big hopes for challenging Taiwanese leaders TSMC (Taipei: 2330; NYSE: TSM) and UMC (Taipei: 2303; NYSE: UMC) for a share of the lucrative global market for made-to-order microchips that power everything from LCD televisions to cellphones. Those hopes were never quite realized, largely due to poor management that led SMIC to report a steady stream of losses for most of its life as a publicly traded company. Things finally appeared to be improving after a change in top management nearly 2 years ago, but then the company stumbled again following an internal power struggle last summer. (previous post) That struggle was finally resolved and the company again seemed to be making progress on a turnaround, which, in my view, could now seriously be jeopardized if SMIC buys or tries to operate some of Elpida’s assets. Such assets would be a huge distraction for SMIC, which has no experience operating outside its home China market. Furthermore, the DRAM sector is already super competitive, which is what drove Elpida into bankruptcy in the first place, and I have little confidence that SMIC could succeed in turning around this company, which probably suffered from high costs due to its location in Japan. Obviously no deal has been reached yet, but I still fear that SMIC may be pursuing such a purchase as new CEO Tzu-Yin Chiu, who assumed his position last August, tries to chart a new course for the company. But an Elpida purchase is not the correct route back to profits, and in fact could actually prolong SMIC’s turnaround, leaving it in the red for many years to come.

Bottom line: SMIC should stay away from Elpida, or risk prolonging its losses for years to come if it actually buys or takes over some operations from the bankrupt Japanese firm.

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