Mohnish Pabrai (Trades, Portfolio) is a legendary investor and the founder of Pabrai Investment Funds. He is most famous for winning a charity auction with Warren Buffett (Trades, Portfolio), which led to a lifelong friendship with Buffett’s business partner, Charlie Munger (Trades, Portfolio).
Pabrai’s investments are widely followed and he often talks about his investments in various interviews. In this discussion, I will break down his surprising sale of Micron Technology Inc. (MU, Financial). Let’s dive in.
Micron
Pabrai is known for having a number of “focused” bets. Previously, Micron made up the largest position in his U.S. investment portfolio.
This is why it was surprising to see that he sold all 1.59 million shares, according to 13F filings for the three months ended June 30. The stock traded for an average price of $64 per share during the quarter.
Pabrai is no stranger for making surprising moves, having previously loaded up on Alibaba (BABA) stock before selling out. He admitted in an interview that this was for “tax harvesting” and he still believed in the company’s prospects.
In the case of Micron, Pabrai could be now taking some profit again as he originally purchased the stock at just $37 per share in the fourth quarter of 2018. However, he has then added to his position multiple times over the past couple of years at various ranges close to $85 per share, which is more expensive than where the stock trades at the time of writing.
What does Micron do?
Micron is the fourth-largest semiconductor company in the world and the third-largest supplier of dynamic random access memory, or DRAM. This is an essential building block for all computers, from a mobile phone to a laptop and even a large-scale data center.
The investment thesis is that it is a play on the hunger for DRAM, which will be required to power the next digital revolution.
A forecast by McKinsey indicates the semiconductor industry will reach a value of $1 trillion by 2030. Therefore, Micron is expected to ride this wave.
AI building block
Micron could also benefit from the huge forecasted growth in the artificial intelligence industry. An average server tailored for AI applications uses up to 8 times as much DRAM and 3 times as much NAND (Micron's second major business line), according to Micron’s management.
Specifically, the company has recently launched the DDR5 RAM, which is specifically designed for AI workloads. In general, this new chipset has showcased an 85% increase in performance over the prior generation.
Cyclical financials
A challenge Micron faces is its cyclical financials. In the third quarter of fiscal 2023, the company reported $3.75 billion in revenue, which was down 57% year over year. However, this decline was expected and the revenue result still beat analyst forecasts by $75.5 million.
By product type, Micron generated $2.7 billion, or 71% of its revenue, from its DRAM technology. This revenue fell by 2% quarter over quarter, but shipment volume rose by 10%. Therefore, the dip was driven by a supply glut that impacted prices.
Micron’s NAND revenue was $1 billion, or 27% of the total. This revenue rose by 14% quarter over quarter, while volume increased by 30%. Similar to DRAM, this growth was offset slightly by a mid-teen price decline.
Moving on to revenue by business unit, its Compute and Networking Business reported $1.4 billion, which rose by 1% quarter over quarter. This was driven by strong growth in graphics and server applications. While client (personal) computing struggled due to the industry-wide decline, Micron’s chief financial officer believes data center revenue hit a bottom in the prior quarter and, therefore, is now on an upward trajectory, which could be enhanced by an AI catalyst.
The Embedded Business Unit reported revenue of $912 million, up 5% quarter over quarter, while the Mobile Business unit reported a 13% decline in revenue to $819 million.
Micron’s storage business reported $627 million in revenue, up 24% quarter over quarter on the back of strong shipment volume.,
China ban
On May 21, China’s Cyberspace Administration implemented a ban on Micron’s products due to cybersecurity concerns. This is believed to be a reaction to the U.S. blacklisting certain Chinese products from companies like Huawei and, more recently, the ban given to Nvidia on selling its latest AI chips in China.
Micron has around one quarter of its revenue exposed, but management estimated that approximately half of its China-based revenue would be impacted. Therefore, this is not as bad as initially thought with a low double-digit decline expected.
Margins and balance sheet
Micron reported a $1.6 billion loss in the third quarter, which was down substantially from the $2.9 billion profit reported in the prior year. A positive is its losses have narrowed from the $2.2 billion loss reported in the prior quarter.
The general decline has been driven by the aforementioned price drop across its products, driven by industry oversupply.
Micron reported a loss of $1.73 per share, which beat analyst forecasts by 1 cent.
Moving on to its balance sheet, the company reported $10.5 billion in cash and short-term investments. It also has $13.9 billion in total debt, of which the vast majority ($11.8 billion) is long term.
The company also has a 0.7% forward dividend yield, which looks consistent.
Valuation
Micron trades with a price-sales ratio of 3.94, which is slightly higher than its five-year average. I believe its valuation metrics are skewed by the profitability changes.
This also looks to have influenced the GF Value Line, which states the stock is significantly overvalued with a fair value of $43 per share.
The best figures I prefer to use for the valuation of Micron includes the average guru buy price of $64 per share (where the stock traded at the time of writing). This is the approximate level that investors such as Yacktman Asset Management (Trades, Portfolio) and Ken Fisher (Trades, Portfolio) have been loading up on.
Final thoughts
Micron is good company with a solid market position. The company is expected to benefit from further digitization and the growth in AI. The main challenge it faces at this time is the cyclical decline in the industry, which may take at least a few quarters more to correct.
The sale of the stock by Pabrai is intriguing. The only major fundamental change is the regulatory ban in China. While we know this will give the revenue a haircut, it is not a company killer. Therefore, I believe Pabrai may be wrong on this one, though he may have just sold for opportunity cost, profit-taking or tax harvesting reasons. However, prudent investors may still wish to trim their position slightly due to the China ban.
