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Refresh Your Memory on These Tech Stocks

We discuss our picks and pans in the semiconductor memory space.

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A paradigm shift is under way in computing. Ten years ago, computers sat on desks--now, they slip into a back pocket. This shift toward ultraportability, made possible by innovative technologies for storing data, holds the potential to create enormous wealth. However, the complexity of the subject matter, combined with the tendency for popular press pundits to toss around a bewildering alphabet soup of acronyms and jargon, sometimes makes it hard for the nonspecialist to follow developments in this interesting area. We thought we would do a quick review of memory technology and provide our thoughts about which firms will be the winners and losers in the move to ultraportable computing.

A Bit of Technical Background
The legacy model of computing has a hard-disk drive sending blocks of data to a "data corral" made up of dynamic random access memory semiconductors. DRAM then shuffles the data off to the processor lightning fast whenever the processor calls for it. Hard-disk drives have this problem: Because they are mechanical (basically working on the same principal as Edison's phonograph), they use a lot of power and are slow. Solid-state DRAMs have a different problem: While they're fast, they lose their data as soon as the power is switched off. As long as we remain tethered to a wall socket, this hard-drive-DRAM tag-team arrangement works fine. However, with people increasingly wanting to send e-mails from the back of a taxi and watch full-length movies on their mobile phones, we believe that for portable devices, the days of this legacy model are near an end. If you have any doubt about this, compare one of the first hard-drive-powered  Apple (AAPL) iPods to a new solid-state iPod Shuffle: It's like comparing a 1980s-era  Motorola (MOT) shoe-box phone to a RAZR!

One of the most important enablers of this trend toward portable computing is flash memory. Solid-state (i.e., made from a semiconductor) flash memory comes in two flavors--NAND and NOR. Both flavors store data in the form of charges on a conductive island surrounded by a nonconductive sea. When power is turned off, the charge is stranded on the island, so the data is preserved. This makes flash perfect for mobile computing.

  • It has no moving parts, so it's lightweight and easy on power consumption.
  • It is solid-state like DRAM, so it has quick response times.
  • It doesn't lose data when the switch is off.

We believe that, considering these strengths, in the not-too-distant future it will be as odd to have a hard-disk drive installed in one's laptop as it would be to have a floppy installed now.

However, flash does have some drawbacks, and first and foremost is price. Buying a  Dell (DELL) laptop equipped with a flash-powered 32 GB drive (also known as "solid-state drives" or "SSD") will run you about $450 more than one with a comparable hard-disk drive. However, we believe that manufacturing efficiencies will soon lower this price to a level at which the pull of flash-powered drives' greater functionality and durability overcomes consumer resistance to the incremental cost increase--especially for laptops and other portable devices. The second drawback is functionality. Due to differences in chip architecture, NAND has always been easy to miniaturize but not good at storing programs, while NOR has always been good at storing programs but difficult to miniaturize. Several companies are working on hybrid technologies that will allow both code and data to be efficiently stored and accessed using the same memory module. When this dream becomes a reality, you will be able to carry around a memory stick containing all the programs and data you need. When you need to do some work, you will sit down at any dumb terminal, plug the memory stick in, and see the same desktop and documents you could see at your home or office.

Three Semiconductor Stocks: Winners or Losers?
With this background in mind, let's take a look at a few companies.

 SanDisk (SNDK)
Business Risk: Above Average
Economic Moat: Narrow
Morningstar Rating: 4 Stars
SanDisk is an innovator in the NAND flash space and unlike its competitors, has a strong vertically integrated organization that encompasses everything from NAND research and development to manufacturing to retailing of memory cards and other NAND-powered devices like MP3 players. Licensing revenues from its R&D--which have nearly 100% gross margin--consistently generate one tenth of SanDisk's revenues. SanDisk's manufacturing partnerships with NAND co-innovator Toshiba (TOSBF) allow SanDisk to buy NAND components at a discount to the price its retail competitors must pay, so its retail margins are higher than those of its rivals. Its sales and marketing arm is the 800-pound gorilla of the NAND world, with a number one market share globally for memory cards. Although its business selling memory cards into the digital still camera market is maturing, there are several high-growth products on the horizon. We believe the high-growth areas of selling miniature flash cards to store data in mobile phones, as well as the nascent market for flash-powered drives and secure, configurable memory sticks focused on the corporate computing market, will provide SanDisk with robust growth for years to come.

 Spansion (SPSN)
Business Risk: Above Average
Economic Moat: None
Morningstar Rating: 4 Stars
We believe Spansion has some of the most innovative memory technology and cost-efficient manufacturing facilities around. Although it has struggled with industry overcapacity and vicious competition since being spun off by parents  AMD (AMD) and Fujitsu in 2005, we think it will be ultimately successful in translating its innovative designs and engineering skill into value for shareholders. Spansion has steadily taken NOR market share from numbers two and three, (  Intel (INTC) and  STMicroelectronics (STM)), and we believe this trend will continue even with the recent combination of these two competitors' NOR operations. One of Spansion's big advantages is its proprietary method of cramming two to four times more memory capacity onto a chip while using fewer expensive manufacturing steps. It is also far down the path to making a viable NOR/NAND hybrid (which it calls ORNAND) on a commercial scale. Spansion's high-capacity NOR is especially popular in high-end 3G mobile phones, and the continuing move toward 3G should provide a tailwind to the firm in the near to mid-term. Korean chip giant Samsung (SSNLF) is in the wings and may provide strong competition in the future, but we believe Spansion is well-positioned to create value for shareholders.

 Micron Technology (MU)
Business Risk: Above Average
Economic Moat: None
Morningstar Rating: 3 Stars
We believe that Micron Technology, as the last DRAM producer in the United States, is on the wrong side of the memory battle, and it will have an uphill battle to remain competitive. Micron is attempting to stay relevant by focusing on production of mobile-DRAM (mDRAM) and other specialty memories. It has also entered the NAND flash market via both a joint venture with microprocessor giant Intel and the acquisition of struggling flash retailer Lexar. However, its exposure to old-paradigm computing is still large and we think it will have trouble keeping up with its NAND competitors, which have a technical and marketing lead. Returns on invested capital have never been high at Micron, and we believe it will have a hard time generating ROICs higher than its cost of capital even considering its recent expansion into NAND.

Erik Kobayashi-Solomon does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.