Toshiba's Flashy New Look at Chips

NAND flash-memory chip prices continue to fall, but the industry's recent production pullback and expected market expansion could restore power

by Kenji Hall and Moon Ihlwan

The plunge in global chip prices over the past year is enough to make any semiconductor executive nervous. But you wouldn't have guessed the industry was hurting after Toshiba (TSBF) Chief Executive Officer Atsutoshi Nishida offered one of the rosiest predictions for his company in years.

In his annual outlook on Apr. 12, he attributed Toshiba's rising fortunes to semiconductors, particularly the so-called NAND flash-memory chips that store data in cell phones, portable music and video players, and digital camera memory cards. Over the next few years, the market is expected to expand roughly 24% annually, as more portable gizmos use the tiny chips. Toshiba and Sunnyvale (Calif.)-based partner SanDisk (SNDK) together enjoy about a one-third share of the global NAND market.

By Nishida's reckoning, Toshiba could nearly double its operating profit by March, 2011, posting $4 billion in operating profit on sales of nearly $80 billion vs. the forecast $2.1 billion in operating profit and $58.8 billion in sales for the just-ended fiscal year through March. Return on equity could climb to 15% from just above 11% now. The biggest contributors are NAND flash-memory, hard disk drives, and other devices, which account for 22% of sales but more than half of operating profits.

Nuclear Growth

Another reason for the optimism: healthier profits in markets abroad. "The new business plan puts an emphasis on boosting overseas business to reach sustainable growth," Nishida told a ballroom packed with journalists, financial analysts, and fund managers. He's expecting three-fourths of consumer electronics sales and 56% of chip and hard disk drive sales to come from overseas, up from 70% and 50% last year. He's betting that laptop PC makers will shift to a hybrid of hard disk drives and flash memory. Meanwhile, consumers are likely to snap up the next-generation HD-DVD recorders and players, further fueling chip demand.

Nishida is also counting on Toshiba's acquisition of Westinghouse Electric from British Nuclear Fuels last October to pay dividends, as more countries seek to lower the emissions that are thought to cause global climate change. The demand for nuclear reactors in China, India, and even the U.S. seems real and lasting.

All this is a welcome change from the low-growth years before Nishida took Toshiba's helm less than two years ago. The company's stock has edged up around 7% since January. What remains astonishing is Nishida's belief that the company is on the upswing, despite its own forecasts for annual NAND price declines of upwards of 50%.

Price Free Fall

The gambit obviously won't come cheap. Nishida expects to spend $10.8 billion on research and development over the next three years. That's a 16% jump in spending from $9.3 billion in the past three years and will help fund the blistering buildup of Toshiba's semiconductor business.

As recently as mid-March, analysts might have taken Nishida to task for his naiveté. Back then, market tracker iSuppli cautioned that the market for NAND chips was as bad as it had ever been. A global glut, which had worsened since the last quarter of 2006, was exaggerating the deep discounts of about 70%. It was starting to look like a bad time to be a NAND manufacturer.

But in recent weeks, conditions have improved, and analysts and industry experts are even hoping for a resurgence in demand later this year, due to Apple's iPhone. Ironically, Toshiba has its Korean rivals to thank. That's because Samsung Electronics and Hynix Semiconductor, which control more than 60% of the market, have been curbing supply. The move has prompted tech manufacturers to buy in big volumes while the rock-bottom prices last, allowing NAND makers to sell some of their inventory stockpile, says iSuppli analyst Nam Hyung Kim.

Lack of Killer Apps

The Korean manufacturers haven't been as fortunate. On Apr. 13, Samsung, the world's top memory chipmaker, is likely to report its worst quarterly financial performance in four years. Blame sharp price falls in DRAM (dynamic random access memory) chips used in personal computers and NAND flash memory, analysts say. "A steady growth in memory chip demand for non-PC mobile products was completely overshadowed by too much increase in capacity," says Jay Kim at Hyundai Securities.

Kim and many other analysts expect Samsung to report an operating profit of less than $1.5 billion for the first three months of this year, well below $2.2 billion in the fourth quarter of last year and $1.7 billion in the same 2006 period. That's because DRAM prices are down by more than 20% in the first three months and NAND prices are down by as much as 40%. DRAM demand linked to Microsoft's new Windows Vista operating system so far has been lackluster, while there has been no killer application for NAND chips lately.

Still, if the forecasts of firmer NAND memories hold true, things could turn around for Samsung. "We remain positive for Samsung because earnings are likely to bottom in April," says Young Park at Woori Investment and Securities in Seoul. If that indeed occurs, Nishida's sunny optimism at Toshiba could start to appear justified as well.

Hall is BusinessWeek's technology correspondent in Tokyo . Moon is BusinessWeek's Seoul bureau chief.