DRAM chip makers pay for glut, mistake

By Marie-France Han and Mayumi Negishi - Analysis

SEOUL/TOKYO (Reuters) - After betting on a strong 2007 spurred by sales of new PCs, computer memory chip makers are now locked in a supply war that could aggravate an already heavy glut and threatens to destroy their margins.

Prices of dynamic random access memory (DRAM) chips have tumbled since January, after the chip makers made the mistake of overcompensating for a chip shortage last year, and manufacturers have yet to reduce their output, analysts say.

"There has been a 70 percent drop this year to date," said Simon Woo, an analyst at Merrill Lynch, adding that chips that were selling at $6 early this year were now below $2.

The world's top two makers, Samsung Electronics (005930.KS: Quote, Profile, Research, Stock Buzz) and Hynix Semiconductor Inc. (000660.KS: Quote, Profile, Research, Stock Buzz), are facing an ugly set of second-quarter quarter earnings.

"We expect Samsung's DRAM profit margin in the second quarter to be at breakeven, with overall semiconductor margin dropping to 6 percent from 12 percent in the first quarter," said Song Myung-sup, an analyst at CJ Investment & Securities.

"As to Hynix, it could very well post a 7 percent operating loss in the second quarter," Song said.

Many analysts say DRAM makers have only themselves to blame for the dismal price situation.

"The DRAM industry is returning to a classic market share battle with little regard for profitability, and all vendors are going to suffer," said Andrew Norwood, research vice president at Gartner Dataquest.

The tumble is all the more painful for DRAM makers, as it follows an exceptionally strong 2006 during which DRAM prices dropped by a mere 11 percent, much less than the 30 percent typical annual drop.

The stronger-than-expected prices prompted manufacturers to switch more capacity to DRAM from NAND flash memory chips, which are used in digital cameras and music players, late last year.

Companies kept churning out more and more DRAM memory early this year, aided by ever rising yields, while actual demand for Microsoft's (MSFT.O: Quote, Profile, Research, Stock Buzz) new Vista operating system remained sluggish. To make matters worse, DRAM makers flush with cash decided to keep their output at a high level.

MISCALCULATIONS

"Companies completely miscalculated DRAM demand linked to Vista," said Lee Min-hee, an analyst at Dongbu Securities. "It typically takes at least six months for a new operating system to boost PC sales. For some reason DRAM makers thought Vista would immediately lift sales."

What's worse, nobody seems ready to predict when a turnaround in DRAM prices will take place. A top executive at Hynix said on Wednesday the recovery could start in July or August -- much later than the May or June turnaround point many in the market had expected earlier this year.

Even though the market should recover somewhat in the second half, thanks to demand fuelled by rock-bottom prices, analysts and manufacturers say the year-end picture will be much darker than usual.  Continued...