Shark Repellant and White Knights

Every day seems to bring a new twist to the SanDisk (potential-acquisition) saga. Friday’s news was that Toshiba may buy about half of the equipment SanDisk owns in a joint venture memory chip plant for a cool billion- and that’s dollars.

This could be read two ways. Either Samsung is about to acquire SanDisk and Toshiba wants to insulate itself from Samsung – or – Toshiba is lending its buddy SanDisk enough money to forge forward as an independent company.

When the Toshiba-could-buy-SanDisk’s-equipment news hit around 1:00 PM, SanDisk was green. Following the news, SanDisk promptly sold off, ending the day at the low- down 6%.

Mr. Market seems to think the news is a negative for Samsung’s acquisition offer. I’m inclined to agree.

A billion dollars is real money.

If Samsung had been counting on SanDisk’s not having the resources to play an extended game of IP legal hardball, they’re in trouble now. A billion dollars is about 3 years of lost Samsung royalties. 3 years is probably more than enough time to hang Samsung out-to-dry in court.

If Samsung had been counting on SanDisk not having the capital needed to stay competitive, they’re out of luck there too.

If Samsung had been counting on a weak SanDisk balance sheet to scare off institutional investors, they might need to come up with a new scare tactic.

Toshiba has no interest in seeing SanDisk swallowed by Samsung, its arch-rival. Many have rightly seen Toshiba as a potential White Knight riding to SanDisk’s rescue. While it may yet come to a counter-bid, an equipment buying deal would seem a far more economical scheme to keep SanDisk’s IP out of Samsung’s clutches.

Won vs Yen

Much has been made in the press about Samsung’s deep pockets. Far less attention has been paid to the currency crisis in South Korea.

Year-to-date, the U.S. dollar has strengthened 42% against the South Korean Won.  The Won is at a 44 month low against the greenback. Not such great news for a Won-based company pursuing an acquisition offer in U.S. dollars.

Samsung plans to fund its SanDisk acquisition with internal cash and available financing. That internal cash (Won) would have gone a lot further before the Won’s recent precipitous slide.

Given the current Korean financial crisis, available financing from Korean sources is likely hard to come by. In fact last, week Korean press reported that Samsung would be raising $2 billion abroad to acquire SanDisk rather than placing corporate bonds.

On the other hand, the Japanese Yen is up 9% against the U.S. dollar since the beginning of the year.

Even with currency considerations, I don’t doubt that Samsung has the ability to come up with $5.8 billion dollars ($26/share) one way or another.

Whether Samsung also has the flexibility of sweetening its bid significantly is another matter. I also wonder whether Samsung wants to commit the extra resources that might be required for a protracted hostile takeover attempt.

SanDisk isn’t going to be easy pickings. Shark repellant, takeover defenses, seem to be in place.

Shark Repellant

According to SanDisk’s SEC filings, SanDisk has a number of defenses which could discourage a takeover attempt. These include a stockholders’ rights plan which could trigger substantial dilution in turn increasing the cost to be paid. In addition, SanDisk’s board has been granted authority to issue additional shares with fixed rights, preferences and privileges.

From SanDisk’s latest 10Q filed 8/11/2008:

“Anti-takeover provisions in our charter documents, stockholder rights plan and in Delaware law could discourage or delay a change in control and, as a result, negatively impact our stockholders. We have taken a number of actions that could have the effect of discouraging a takeover attempt. For example, we have a stockholders’ rights plan that would cause substantial dilution to a stockholder, and substantially increase the cost paid by a stockholder, who attempts to acquire us on terms not approved by our board of directors. This could discourage an acquisition of us. In addition, our certificate of incorporation grants our board of directors the authority to fix the rights, preferences and privileges of and issue up to 4,000,000 shares of preferred stock without stockholder action (2,000,000 of which have already been reserved under our stockholder rights plan). Issuing preferred stock could have the effect of making it more difficult and less attractive for a third party to acquire a majority of our outstanding voting stock. Preferred stock may also have other rights, including economic rights senior to our common stock that could have a material adverse effect on the market value of our common stock. In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. This section provides that a corporation may not engage in any business combination with any interested stockholder during the three-year period following the time that a stockholder became an interested stockholder. This provision could have the effect of delaying or discouraging a change of control of SanDisk.”

I was going to add a section here on Toshiba as a full blown white knight, but that’s going to have to wait. Once again I’m running short of time. Suffice it to say that if required, I expect Toshiba will step in to block a Samsung acquisition of SanDisk. Too much is at stake for Japan Inc to cede critical IP in solid state storage to the Koreans.

My favorite Toshiba-as-White-Knight scenario includes other big-name Japanese companies who would stand to profit from a piece of the action.

All this being said, I acknowledge that my crystal ball is cloudy. While I still feel that in all likelihood SanDisk will emerge from this downturn as an independent company, I’m prepared to be surprised. Respected friends don’t share my views.

One points out that Samsung officers were seen recently in SanDisk offices in Kfar-Saba. Due diligence or something else?

Another points out that SanDisk’s largest shareholders are the same as Yahoo’s. Hypothesis being that these folks are not going to put up with deja vu all over again.

Paraphrasing that old Chinese curse, these are interesting times for SanDisk.

Tomorrow along with miserable earnings, I don’t expect much in the way of news. “No comment” will be the likely refrain.  No comment on acquisition talks with Samsung. No comment on license renewal talks with Samsung. No comment on the potential equipment deal with Toshiba.

[Edit 20 October 2008: The Toshiba equipment deal was announced this morning, so there should be plenty of detail in the cc.]

It should be interesting to hear what SanDisk has to say (if anything) about x4 and MDOC IP in light of SanDisk’s arbitration win over Samsung.

In any case, my hope is that top line growth is healthy and inventory overhang is under control.

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3 Responses to Shark Repellant and White Knights

  1. Poofypuppy says:

    Hi Savo,

    It looks like you are right, a Samsung acquisition doesn’t appear imminent. From yesterday’s quarterly earnings call, it seems that Eli is prepared to play the brinksmanship/waiting game with Samsung all the way to August 2009 if need be.

    ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
    “Shifting now to IP matters, earlier this year we won a binding arbitration ruling in the Samsung-msystems case involving license rights to the msystems patent portfolio that we acquired in 2006. An arbitration panel ruled that Samsung breached its agreement with msystems and had therefore forfeited its perpetual license rights to msystems patents, including patents covering X4, that’s 4 bits per cell NAND, and patents that teach important system level flash technologies. Samsung appealed this ruling in federal court but subsequently withdrew and asked the court to enter judgment against them. The net effect is that absent a patent cross license renewal by August 2009, Samsung will not be licensed to either msystems or SanDisk’s patent portfolios.

    The final topic I want to address is Samsung’s proposal. As you know, Samsung indicated an interest to acquire SanDisk for $26 per share. SanDisk’s board made it clear to Samsung in a letter dated September 15 that it is open to a transaction at the right price with the right process and the right protections for SanDisk’s shareholders. Our board strongly believes that Samsung’s indication of interest significantly undervalues SanDisk, both in the absolute and in light of the synergies and the value of our IP to Samsung. Samsung stands to gain enormous value from owning our patents and our know-how; in particular, the hundreds of second generation patents for mobile storage that we developed in-house or acquired in the past decade. These second generation patents extend well into the next decade, and therefore the intrinsic value to Samsung is highly strategic and long-term.

    The future of the mobile storage industry we believe is in All-Bit-Line ABL-multi-level cell 3 bits per cell MLC, 4 bits per cell MLC, managed NAND, 3D Read/Write, advanced controllers, mobile security, and solid-state drives. SanDisk holds many of the fundamental patents and know-how for these technologies and Samsung knows it. This is why owning these patents and the know-how is so critical for Samsung’s future profitability.

    The SanDisk board of directors remains open-minded about a potential transaction with Samsung. Our board is focused on the right price and the right protections for our shareholders, including the renewal of the Samsung IP patent cross license in case a transaction does not close. This was formally and publicly communicated to Samsung and as of this time, there have been no further communications between the two companies on this topic.”
    ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

    So Eli says the SanDisk board wants an IP renewal deal in place first, before they will discuss potential acquisition. This is an interesting/clever strategy that forces Samsung to negotiate the actual value of SNDK/FLSH’s patent portfolio to them, whereas Samsung thought they could swoop in and buy SNDK in a down market and thereby bypass the entire royalty stream issue. Given SanDisk’s new infusion of cash (from the partial sale to Toshiba) and “no further communications” from Samsung, it looks like SanDisk is content to go back inside their house for the winter and let Samsung sweat/freeze outside. If no IP renewal deal is announced, things should get really interesting in June or July of next year. Yes indeed, the saga continues.

    Regards,
    Poofy

  2. savolainen says:

    Hey Poofy,

    Yep I also appreciated Eli’s point that a renewal of the Samsung IP patent cross-license is precondition for in-depth acquisition negotiations. Not only would a resign be a gesture of good faith, but it would give SanDisk a bit of protection against IP theft.

    As part of its due diligence, I imagine Samsung would want access to the best of SanDisk’s secret stuff so as to determine the status of the most promising technologies. Before providing such a guided tour, best to know that at least a license is in hand should the deal fall apart at the eleventh hour.

    I also thought it revealing that Eli said that there had been no communication between Samsung and SanDisk since September 15. Eli would never have said this if it wasn’t true. A nice safe way to say a lot with few words.

    All-in-all I thought the cc was quite informative. Much more sensitive stuff was addressed than I was expecting. For sensitive topics, I like this approach of carefully crafted limited statements far better than than the far easier– no comment.

    In hindsight its unbelievable how much Samsung lost by screwing over FLSH. They had perpetual license rights to msystems whole patent portfolio and then threw it all away just because they thought they could get away with stiffing a little guy.

    What a great lever FLSH’s patent portfolio would be today in negotiations with SanDisk.

    Its been said arrogance diminishes wisdom. This could be a case study.

    And it looks like Samsung is going to have plenty of opportunity to contemplate how much they lost– and how much they are going to have to pay. Eli is showing no signs of backing down.

    Best,
    Savo

  3. savolainen says:

    Greetings all,

    Well today, somewhat predictably, Samsung withdrew its $26/ share offer. If Samsung’s intent is to keep the heat on SanDisk, this was the move to make. Why lend any support to a share price you want beaten into the ground?

    I expect Samsung to now sit back and wait to see if shareholders can/will exert enough pressure on Eli and the board to force SanDisk to come crawling back to the table on Samsung’s terms- either for acquisition or for license renewal at reduced rates.

    Judging from the tone of SanDisk’s response, this latest ploy isn’t going anywhere either:

    http://investor.sandisk.com/phoenix.zhtml?c=86495&p=irol-newsArticle&ID=1215427&highlight=

    “From the start of this process SanDisk’s Board has remained open to a transaction that recognizes SanDisk’s long-term value and contains the right protections for SanDisk’s shareholders. We repeatedly outlined a clear path to hold further discussions, including most recently in our letter on September 15, and Samsung consistently chose to ignore that path and, in fact, never contacted SanDisk regarding their proposal after we delivered our letter. We believe this raises questions about the real motivations behind Samsung’s offer.”

    No post this weekend. I’m off to say hi to the Rocky Mountains.

    Regards,
    Savo

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