The challenges of operating in an unpredictable global macro environment have had an impact on all global businesses. Slowing economic growth, first from the prolonged and volatile China-US trade wars in 2019 and COVID-19 in 2020, have had a knock-on impact on the global economy.
Global equity markets have continued to fall because of the limited visibility of when the COVID-19 pandemic will be under control and the difficulty of estimating the scale of the potential damage to the global economy. We believe it is not a valuation issue at the moment but a confidence issue. As shown in Chart 1, total newly confirmed cases of COVID-19 in China, peaking between February 4 and February 13. We are waiting for the peak in the U.S. and Europe.
Server Market Dynamics
The virus outbreak will, no doubt, bring short-term challenges to supply chains and logistics, but it is also likely to accelerate the time spent online.
The COVID-19 epidemic has unexpectedly breathed life into the server market, decimated in 2019, which stretches from virtual meetings, online education, digital healthcare, cybersecurity, telecommunications, logistics to smart cities. Server capex spend grew just 5.8% in 2019, following a 48.7% increase in 2018.
Alibaba Cloud (NYSE:BABA) is offering $1,000 of credits to purchase cloud services to organizations that have been impacted by the Coronavirus outbreak, to ensure business stability. In addition, Alibaba Cloud made its cloud-based AI-powered computing platform available for free to global research institutions to accelerate viral gene-sequencing, protein-screening and other research in treating or preventing the virus.
Alibaba Cloud also helped government departments across 20 provinces and counties to develop their online IT management platforms to better keep track of and communicate on the latest developments of the coronavirus outbreak.
Alibaba Cloud maintained high growth for the fourth quarter ended 31 December 2019, with revenue growing 62% year-over-year to RMB10.721bn (US$1.540bn). The growth was reported as part of parent Alibaba Group’s posted quarterly results. The leading Chinese cloud service provider said sales were driven from both its public cloud and hybrid cloud businesses.
Micron Technology (MU) expects cloud DRAM bit demand to grow faster in 2020 than Micron’s industry-wide forecast for mid-teens demand growth. Also, cloud DRAM bit demand has been growing at a 20%-plus compound annual rate in recent years, while cloud demand for NAND flash memory is likewise growing faster than industry-wide NAND demand growth. NVMe client SSD bit shipments represented almost three-quarters of MU’s client SSD bits in fiscal Q1, versus virtually none a year ago.
Chart 2 shows DRAM demand by quarter for PC DRAM, Servers, Mobile DRAM, and others. Mobile DRAM is the largest user of DRAMs followed by servers. Note that there is a drop in Q4 2019 for mobile and a drop in Q1 2020 for servers, which is tied to the inventory overhang by server suppliers that is just starting to work through the industry. DRAM demand for servers will exhibit a CAGR (compound annual growth rate) of 17.5% between 2018 and 2021, according to our report entitled “Hot ICs: A Market Analysis of Artificial Intelligence, 5G, CMOS Image Sensors, and Memory Chips.”
Not surprisingly, by application, we see server DRAM prices leading the price increase, up 6% QoQ in February 2020.
Our supply-chain channel check reveals that large cloud companies are placing orders in greater amounts and at higher prices than anticipated. Contract prices for 32 GB server modules have been set at $145 for 2Q (April-June) The latest contract price represents an increase of around 33% over January 2020 prices, as shown in Chart 3.
Server Capex Spend
The biggest cloud data center Capex spenders in the world – Amazon (AMZN), Facebook (FB), Google (GOOG) (NASDAQ:GOOGL), and Microsoft (MSFT) – are reverting from capacity consumption to data center expansion in 2020, as shown in Table 1.
Capex spend is forecast to increase 12.3% in 2020 following a dismal 2019 that resulted in low ASPs and high inventory overhang of chips at memory companies as expansion stalled. My sources indicate that DOI (days of inventory) for server DRAM now averages 34 days compared to 75 days in mid-2019.
The worst in COVID-19 is still ahead of us in the U.S. and Europe, but has subsided in China and Korea, which are key regions for memory chip production. I am not aware of any significant production disruptions if any, but the fallout of the virus has been harsh, to say the least. If there are any bright sides, it is in the normalizing of memory chip production, bit growth, and ASP increases for server DRAMs and NAND.
Memory capex spend is ramping as cloud service providers are signing deals for 2Q shipments at contract prices of $145 per 32 GB server module, which will bring contract ASPs to Q2 2019 levels. The rise in demand is attributed to the changing business environments brought about by COVID-19.
I see two ramifications of this server demand:
- Memory companies are increasing their mix of server DRAM bit shipments from approximately 35% in 2019 to 45% in 2020.
- The move away from mobile DRAM bit shipments to server DRAM is mitigating the eroded demand of smartphones witnessed by China’s smartphone sales 1Q plunge of more than 40% and uncertainty in smartphone demand in 2Q in the US and Europe as COVID-19 spreads.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.