Deep|Memory: Sustaining the Supercycle – AI-Driven Necessity and Formidable LTAs
TLDR: Historically, Long-Term Agreements (LTAs) were tools for memory vendors to protect themselves; currently, LTAs are being utilized by customers to ensure their own protection.
Assessing Market Perception
The current conservative “wait-and-see” attitude held by the market toward the memory industry stems primarily from the high volatility and strong cyclicality observed over previous decades. Investors who have experienced the drastic fluctuations of consumer electronics demand tend to maintain cautious expectations, overlooking the emerging structural factors supporting the industry’s ongoing transformation.
The core demand for memory has shifted from highly seasonal consumer electronics to infrastructure AI requirements. Within AI computing architectures, memory has become a critical bottleneck for system performance. This elevated status within technical architectures means that traditional cyclical models, which focus on end-consumer goods, have seen a decline in predictive accuracy.
LTAs Enhancing Earnings Visibility for Next 3-5 Years
In the past, LTAs typically featured one-year terms characterized by “locked volume but floating price,” where prices were renegotiated quarterly based on market fluctuations. During previous consumer electronics cycles, customers often treated LTAs as scrap paper and defaulted when demand weakened, while vendors, who were fearing the loss of future business, lacked substantive punitive mechanisms. However, current LTA negotiations differ fundamentally; the bargaining leverage has completely reversed. New LTA terms provide memory vendors with unprecedented protection and profit guarantees.
Vendors are demonstrating an extremely firm stance, resulting in three fundamental shifts in LTA negotiations:
Significantly Extended Contract Durations: Terms have shifted from one year to long-term agreements spanning 3 to 5 years.
Substantial Prepayments: Vendors are now mandating significant prepayments as a prerequisite for capacity allocation. Certain vendors have even proposed requiring customers to provide a lump-sum prepayment covering one year (or potentially longer) of supply. These funds serve as a rigid enforcement mechanism; should a customer breach the contract or fail to take delivery, the prepayment will be immediately forfeited as a penalty.
High “Bottom Price” Locks: This is the most critical change. Using SanDisk as a benchmark, vendors are seeking to establish current Q2 prices, which have already surged by 80% to 100, as the absolute “bottom price” for the next 3 years. If successfully negotiated, this framework implies that future prices will only adjust upward from this elevated base, effectively eliminating any downside room. Currently, we believe that even if the spiked Q2 price is not fully adopted as the floor, there is a high probability the baseline will settle between Q1 and Q2 price levels.
Currently, only a few customers have successfully signed formal 3-to-5-year LTAs. Progress is slower than the original target because vendors are maintaining strict discipline amidst severe supply shortages, while customers continue to negotiate for better terms. Vendors currently prefer to hold off on negotiations rather than concede on the key tenets of bottom pricing and prepayments to ensure the integrity of their 3-to-5-year profit structures.
Furthermore, LTAs have become a tool for vendors to evaluate future partnerships. Capacity allocation is now directly linked to a customer’s historical compliance record. Customers who defaulted during previous downturns now face extreme supply constraints, while those who honored their contracts receive full support to ensure supply stability. While investors might misinterpret CSP resistance to these LTAs as weakening demand, it is actually a reflection of CSPs attempting to secure more favorable terms while vendors remain in no rush to sign. Given the severe supply-demand imbalance, the vendor’s position is clear: if a customer cannot accept the terms, capacity will be prioritized for competitors willing to pay premiums and provide prepayments.
Regarding recent spot price trends, we believe the impact on memory vendors’ actual profits is negligible. Previous spot price increases were driven by distributor hoarding; now, as the PC DIY and aftermarkets cannot sustain these high prices, a natural correction is occurring. It is important to emphasize that the spot market accounts for a much smaller portion of revenue compared to the contract market, and spot participants (distributors) are largely decoupled from the AI-driven contract market. In fact, as CSPs secure their supply through 3-to-5-year LTAs, their need to acquire premium supply in the spot market has decreased. These are the core drivers of the spot price pullback and the spot market trend should not be misinterpreted as a sign of overall demand weakening.
Rational Supply Discipline and Objective Constraints
Unlike the capacity races of previous expansion phases, current market participants are exhibiting high levels of CapEx restraint. Strategy has shifted from market-share competition to a “rational oligopoly”. Having learned from the catastrophic collapses caused by aggressive over-expansion in the past, the remaining few players understand the risk of collective destruction and are exercising caution in CapEx.
