Inotera prices GDRs at the maximum 10% discount

Inotera Memories, a Taiwanese contract memory chip maker, has raised $312.3 million from a sale of global depositary receipts, which aside from replenishing its expansion capital also served to significantly boost its international shareholder base.

The share sale, which was arranged by Credit Suisse, comes as industry players and analysts are expecting a turnaround in the cycle for dynamic random access memory (DRAM) chips following 18 months of falling prices and subdued demand. Inotera is also about to migrate its silicon wafer production from 70 nanometre (nm) trench process technology to 50nm stack process technology, which will make it more competitive and help it catch up with Korean DRAM makers like Samsung and Hynix, which are already employing this new technology.

In the share sale document, Inotera noted that the adoption of the 50nm stack process technology will significantly increase the memory density of its wafers, allowing it to improve its productivity and reduce its per bit manufacturing cost. The company makes primarily DDR2 DRAM wafers and the newer and more efficient DDR3 DRAM wafers (expected to become the industry-wide standard from 2011) for use in computers and mobile phones.

Meanwhile, the introduction of US semiconductor manufacturer Micron as one of Inotera's two controlling shareholders in November 2008 (alongside Nanya Technology) added a bit of extra spark to this particular deal.

"The basic story here is that Inotera is going to be the big survivor in the Taiwan DRAM sector," said a source familiar with the company, who noted that other Taiwanese companies like Powerchip, ProMOS and Winbond are struggling to stay afloat and are likely to be absorbed into the new memory company that the government is in the process of establishing as a way of rescuing a number of quasi-bankrupt Taiwanese DRAM manufacturers.

"With Micron and Nanya both as shareholders and its biggest customers, [Inotera] is in a position to basically become the best-cost manufacturer out of Taiwan," the source said.

However, the company still has a high gearing with a ratio of total borrowings-to-shareholders funds of 177% at the end of June this year. It also failed to meet certain financial covenants on its loans both at the end of 2008 and at the end of June, although its lenders subsequently agreed to waive the financial ratio test on these two dates as well as on December 31, 2009, thus preventing the company from going into technical default.

In other words, investors needed to get comfortable not only with the outlook for the memory chip industry as a whole, but also with Inotera's funding situation, future expansion plans and ability to roll over its debt in the next couple of years. Together with the low foreign ownership -- estimated at only 3%-5% prior to the deal -- these were among the key reasons why the management chose to do a roadshow spanning just over one week, including four days in the US, so that it would have time to explain its story to investors. 

Observers also note that the DRAM sector is always a difficult one to raise capital for, simply because the companies burn through so much cash in their efforts to add capacity or upgrade their technology, which in the past have been key ways for them to cut per unit costs and stay competitive. The current financial crisis has led to a significant reduction in expansion plans across the industry, however, and as a result gobal supply is expected to stay much more in line with the projected demand over the next few years.

Inotera is a case in point. Having spent NT$23.9 billion ($735.9 million) on capital expenditures in 2008, it spent only NT$1.6 billion in the first half this year and plans to invest that same amount again in the second half for a 2009 total of NT$3.2 billion ($98 million). The money will add no new capacity, but will be used to convert its existing capacity of 130,000 wafer starts per month to stack process technology.

In the end, sources estimated that the level of demand for the GDRs was still fairly modest at 1.1 or 1.2 times the shares on offer, but said it was sufficient in order to scale back some players. Five of the top six orders in the book were also said to be tier-1 global long-only names of the kind that take a fundamental view, suggesting that some investors at least did buy the story. In all, some 50 investors participated in the transaction.

Despite the strong marketing focus on US investors, the demand was said to be skewed towards Asia and Europe, with those two regions taking about 35%-40% each, while onshore US accounts bought the rest. Long-only funds took 51%, while hedge funds took 49%. 

The weaker interest out of the US surprised some observers who noted that the acquisition of a 35.5% stake in Inotera is avery  positive story for Micron as it will increase the US company's capacity by 50% and bring its market share from the single digits to the mid-teens - at a significantly lower cost than it would have been able to on its own. Or as Micron's chairman and CEO, Steve Appleton, put it at the time of the acquisition agreement: "Micron will gain greater scale in DRAM, reduce our operating expenses per wafer and have access to a very cost competitive operation."

Consequently, one might have expected that Micron's large US shareholders would be supportive of Inotera's capital-raising to ensure it has the funds to carry on with its expansion plans.

Demand from all regions may, however, have been hampered by the fact that Inotera's Taiwan-listed shares rose 15.5% during the marketing and would have been up 25% had it not been for a sizeable drop in the final two days before the pricing at the end of New York trading last Thursday. While definitely unusual, especially when considering that the sale will result in a dilution of more than 16% for existing shareholders, one source said the underlying share price was basically driven by strong sector fundamentals, including good earnings from Samsung, positive third quarter guidance for the DRAM market by Hynix and rising DDR3 prices. At the same time, deal-related activity would have been limited since there is no stock borrow available on Inotera, making it difficult to sell short.

Essentially, international investors had very little impact on the domestic share price while the deal was ongoing, while domestic investors were paying little attention to the fact that there was a share sale happening at all, the source said.

Potential international buyers were definitely aware of the rising share price, however, and a large portion of them submitted orders specifying that they would buy only at a 10% discount to the underlying shares -- the maximum allowed under Taiwan regulations, unless the company agrees to do a concurrent offer to existing non-affiliated shareholders at the same price, in which case the discount may be as wide as 20%.

While Shin Kong Financial and Chunghwa Picture Tubes, which both sold GDRs through accelerated bookbuilds the week before Inotera, elected to adopt the new regulations that gave them the flexibility to price at a discount of up to 20%, Inotera chose to use the old regulations and thus committed to price that offered a maximum discount of 10%. Shin Kong was eventually able to price its $375 million offering at a 9.9% discount, while CPT priced at a 19.7% discount after increasing the international portion of the $295 million deal by 22.5% to more than 98% of the total.

Not surprisingly, Inotera needed the full 10% to attract sufficient demand and with one day left of the bookbuild, the deal "effectively became a fixed price offering", the second source said. Based on Thursday's closing price in Taipei of NT$17.80 this translated into a price of NT$16.02 per common share, or NT$4.88 per GDR. Each GDR accounts for 10 common shares. The share price fell another 3.9% in Taiwan trading on Friday.

The company offered 64 million GDRs, which corresponded to 19.2% of the existing share capital or 16.1% of the enlarged capital.  

Inotera was founded in 2003 as a joint venture between Nanya Technology, which is part of Taiwan's Formosa Group, and Qimonda, a listed subsidiary of Germany's Infineon - at the time two of the world's leading makers of DRAM semiconductors. Since Inotera's listing in March 2006, they have each held 35.5%. However, in November 2008, two months before it filed for bankruptcy, Qimonda sold its entire stake to Micron. The change of shareholders has allowed Inotera to start using Micron's 50nm stack process technology. The Taiwan company plans to start pilot production based on this technology later this quarter and intends to fully phase out the trench process technology that it has licensed from Qimonda and Nanya by the end of 2010.