The biggest piece of news to come out of Micron Technology's (NASDAQ: MU) May 21 analyst and investor event was a massive $10 billion share buyback program. Starting in September, the memory chip manufacturer plans to transition from debt reduction to capital returns, aiming to use at least 50% of its free cash flow to scoop up its own shares.
This buyback announcement struck me as odd, because it was just seven months ago that Micron was doing the exact opposite. The company sold about $1.2 billion of shares in a public offering in October, with most of the proceeds going toward paying down debt. Those shares were sold for $41 each, far below the current market price of nearly $60.
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Micron sold 29.3 million shares in October, raising $1.19 billion. The company used that money as part of a $2.25 billion debt-reduction plan, redeeming its 7.5% senior secured notes and 5.25% senior notes, both due in 2023.
This was probably a smart move. At the time, Micron had nearly $10 billion of total debt and about $5.4 billion of cash, cash equivalents, and short-term investments. The stock had soared nearly 150% over the previous year, driven by surging prices for the company's DRAM memory chips. The memory chip industry is cyclical, going through booms and busts. Micron using its elevated stock price to pay down debt when times are good makes a lot of sense.
What makes less sense, at least to me, is turning around seven months later, with the stock substantially higher, and announcing a giant share buyback program. This move reflects some extreme optimism on the part of management. Reading through the company's analyst day presentation, it's as if management isn't even entertaining the possibility of a downturn. Ever. They're projecting things out to 2021, and in some cases 2025, despite the company's poor record of forecasting industry conditions.
They'll either be very right, or very wrong.
What could derail Micron?
Micron's management is arguing that there are structural changes in the memory chip industry that will prevent the kind of wild swings in demand that plagued the company in the past. Demand for memory chips for use in data centers, self-driving cars, and the Internet of Things, along with stable supply growth, are expected to keep prices high and Micron's profits fat. If you believe that, buying back $10 billion of stock makes sense.
What could go wrong? A lot of things. Supply could ramp up at some point down the road as competitors try to steal away market share or simply take advantage of high prices. Analysts at Gartner are predicting a supply-induced downturn in 2019 driven by new capacity and China's entry into the market. Of course, Gartner is no more likely to be right about market conditions next year than Micron. But a slump in prices certainly isn't out of the question.
Demand could also fall short of expectations. Micron expects cloud data center annual capital investments to more than double by 2021 to $108 billion, driven in part by increasing demand for artificial intelligence workloads. Micron sees AI-capable servers growing from a tiny fraction of the server market to nearly half by 2025.
Those estimates will almost certainly be wrong, because forecasting anything related to technology seven years in the future is little more than guessing. Micron is also projecting that fully autonomous vehicles will require 74 GB of DRAM and 1 TB of NAND per vehicle by 2025, with 26 million vehicles equipped with Level 3 autonomy or higher shipping by that year. Maybe, but also maybe not.
Optimism can be dangerous
Overoptimism about future sources of demand is exactly what causes oversupply, leading to plunging prices and vaporized profits. Micron's massive buyback program comes at time when the company is enjoying one of its strongest periods on record. It's betting that this period won't end, going against the entire history of the industry.
Micron could be right. Maybe something has changed about the memory chip industry. Maybe spending $10 billion on buybacks, seven months after selling shares at a lower price, instead of paying down debt further will work out just fine. But that's certainly not a bet I'm willing to make.
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