February 2009 Analyst Excerpts

Below are excerpts from three analyst reports released right after the Q4 conference call in early February.

None are excited by SanDisk- even at these prices.

Deutsche Bank maintained its Hold rating, but dropped its price target to $10.

Goldman Sachs downgraded SanDisk from Buy to Neutral and removed SanDisk from its Americas Buy List. 12 month price target: $10.

JP Morgan is the bear of the group with a $5 price target. Sounds to me like JM Morgan has been drinking Samsung’s Kool-Aid. But read-on, JP’s comments speak for themselves.

When reading these excerpts its worth remembering that they were written on either 2 or 3 February, before panic over the shelf registration had passed.

****

Deutsche Bank

2 February 2009
SanDisk

4Q08 Results – One step
forward, two steps back

Bob Gujavarty
Research Analyst

Ross Seymore
Research Analyst

Share sale in the works?

SNDK delivered strong 4Q08 results and is taking solid steps to improve cash flow and excess supply. However, poor guidance and the potential for a dilutive $300- 500m equity offering suggest there is little upside to the share price. Industry supply growth appears to be moderating, but we remain cautious ahead of true pickup in demand. Maintain Hold rating, but drop P/T to $10 on lower 2009E revs.

Solid 4Q08, revenue at high-end of range

SanDisk reported solid 4Q08 results. Revenue of $864m was at the high end of guidance ($725-875m) and well above DBe ($724m) and Street ($767m). The higher revenue was due to better product revenue ($742m vs. DBe $597m) with retail sales in NA & EMEA, offsetting lower OEM and license revenue ($122m vs. DBe $127m). PF loss of (-$1.65) was substantially higher than DBe loss of (-$0.31) and Street, loss of (-$0.60) largely due to the lower GM. The $388m of COGS charges negatively impacted results by approximately $1.13 while restructuring charges ($31m) negatively impacted PF EPS by $0.10.

Lowering 2009 revenue estimates sharply

Based on new guidance we revise our 1Q09E to $524m/PF loss of (-$0.30) down from $673m and PF loss (-$0.17) previously. Implied in our latest estimate is product GM of -10%, bit growth of -25% q/q, and ASP decline of -25%. For 2009E our estimates drop from $2.8bn/PF loss (-$0.32) to $2.1bn/PF loss (-$0.73). We now expect Product GM to stay negative through 1H09. Our full year 2009 Product GM declines from 1.4% previously to -2.3% with only some of the margin decline offset by lower operating expenses.

Lower P/T to $10

SNDK currently trades at trough valuations on P/S & EV/S. Given the poor outlook for NAND flash in 1H09 and an uncertain demand environment we believe trough valuations are appropriate. Our $10 P/T equates to a P/S of 1.0x our 2009E sales, inline with historical trough valuations. We view a take-over by Samsung as unlikely. Downside risks: excess NAND supply, share loss, & manufacturing excursions. Upside risks: market share gains, improved brand awareness of SanDisk, and development of new royalty and IP around X3 and X4 technologies.

Details
4Q08 Results

SanDisk reported solid 4Q08 results. Revenue of $864m was at the high end of guidance ($725-875m) and well above DBe ($724m) and Street ($767m). The higher revenue was due to better retail sales in North America and EMEA while OEM revenue was weaker than expected. Product revenue of $742m was +7% q/q but down -31% y/y. We estimate retail revenue of $539m, +25% q/q and OEM revenue of $203m, -21% q/q. We note OEM revenue was down for the 4th consecutive quarter as handset card units and ASPs both came under pressure. License revenue of $122m was slightly lower than DBe ($127m) as bit growth and ASPs at SNDK licensees was lower than expected. Product GM was negative -$623m, but exclusive of $388m of charges Product GM would be -10% compared to DBe of -3.3%. Charges to COGS consisted of inventory charge-offs ($184m), underutilization charges ($121m), and impairment of fab investments ($83m). Product GM was negatively impacted by aggressive pricing the quarter as well as lower unit cost reductions. ASP declines of -28% q/q were inline with our expectations, but bit growth of +49% was far higher than DBe of +20%. Unexpectedly inventory excluding the charge would be up q/q. Inclusive of the charge-offs inventory declined $114m q/q, to $598m.

PF loss of (-$1.65) was substantially higher than DBe loss of (-$0.31) and Street, loss of(- $0.60) largely due to the lower GM. The $388m of COGS charges negatively impacted results by approximately $1.13 while restructuring charges of $31m negatively impacted PF EPS by $0.10. Operating expenses of $231m (ex restructuring charges) was inline with DBe.

SNDK likely gained market share in retail as the company successfully transitioned the market to higher density products. Retail card density grew +30% q/q to just under 4GB. Total Mbytes grew +49% q/q and represented the best q/q performance since 3Q07. OEM revenue was $202m, down -21% q/q and -49% y/y. The y/y performance is the worst decline since 4Q01 and is further evidence of slowing handset volumes, especially at the-high end of the market.

We estimate NAND Contract ASP were down -13% q/q in 4Q08 a moderation from the -15% decline in 3Q08 and significantly better than SNDK’s own ASPs decline of -28%. If prices were to remain flat at current levels, contract prices would be down another -5% q/q in 1Q09, compared to SNDK expectation of continued “severe” price declines. We believe SNDK is aggressively working down inventory and price cuts put in place in late 3Q08 cannot be revoked now that prices have started to improve. We believe SNDK is likely to see market share gains through 1H09 but at the expense of margins.

Estimates & Revisions

SNDK expects captive bit growth of <50% in 2009, compared with growth of +180% in 2008. Although pricing is expected to remain difficult in 1H09, the company believes ASP declines will moderate to -40-50%, compared to the -60% decline in 2008 due to supply cuts by SNDK and the rest of the industry. However SNDK’s own cost reductions are likely to moderate from -56% in 2008 to -40-50% in 2009 as the company reduces fab utilization and grows non-captive supply. Based on new guidance we revise our 1Q09E to $524m/PF loss of (-$0.30) down from $673m and PF loss (-$0.17) previously. Implied in our latest estimate is product GM of -10%, bit growth of -25% q/q, and ASP decline of -25%.

We tweak our 2009E lower, from $2.8bn/PF loss (-$0.32) to $2.1bn/PF loss (-$0.73). We now expect Product GM to stay negative through 1H09. Our full year 2009 Product GM declines from 1.4% previously to -2.3% with only some of the margin decline offset by lower operating expenses. On a more positive note we expect lower capex combined with assets sales should greatly improve SNDK’s liquidity in 2009. We introduce formal 2010E of $2.1bn/PF loss (-$0.32).

Valuation & Risks

SanDisk remains a unique semiconductor company because of its vertical integration and branded systems business. Given the lack of an appropriate peer group we choose to base our valuation on SNDK’s own historical P/E and P/Sales metrics. Given the cyclical and seasonal nature of the NAND flash market we believe that historical data provides the best basis for peak, base, and trough valuations averaged over periods of excess supply and shortages.

SNDK currently trades at trough valuations on P/S and EV/S. Given the poor outlook for NAND flash in 1H09 due to excess supply and an uncertain demand environment we believe trough valuations are appropriate. Our $10 P/T equates to a P/S of 1.0x our 2009E sales since we do not expect SNDK to generate earnings in 2009. Our P/Sales ratio is inline with historical trough valuations (1.0x). We continue to view a take-over by Samsung at $26 per share is a low probability event.

SNDK faces risks on multiple fronts, not least of all those associated with the broader NAND flash market. In terms of company-specific risks, we consider the most pertinent to be the sustainability of current License & Royalty revenue streams (particularly with Samsung post- 2009), the ability to cost effectively source NAND flash beyond its primary partner Toshiba, being more exposed to removable storage flash form factors (which are expected to grow less quickly than the embedded NAND segment), as well as the ability to stave off commoditization of flash cards and UFDs through IP and market leadership in new standards.

Positive risks include market share gains, improved brand awareness of SanDisk outside of the flash card market, and development of new IP and royalties around X3 and X4 technologies.

**** Goldman Sachs Excerpts Below ****

Goldman Sachs
February 2, 2009

Removed from Americas Buy List
SanDisk Corporation (SNDK)

Downgrading to Neutral due to dilution from equity offering

James Covello, Goldman, Sachs & Co.
Kate Kotlarsky, Goldman, Sachs & Co.
Mark Delaney, Goldman, Sachs & Co.

What happened

We are downgrading SanDisk to Neutral from Buy. After a very weak Q4’08 report and outlook, management announced that the company plans to do a $300-$500mn equity offering in ‘09 in order to give SanDisk a cushion in an uncertain economic environment. We believe that the offering will be significantly dilutive (12% to 20% share dilution) and is particularly disconcerting given SanDisk’s recent refusal of a $26/share offer from Samsung vs. its willingness to do an equity offering today at $11. As a result we are downgrading the stock, with shares up 22% since our Buy rating on 11/3/08 vs. the S&P -15% and -59% yoy vs. the S&P -41%.

Current view

While there is no change to our view that SanDisk retains some of the key IP in the NAND industry and believe that SanDisk’s royalty business could be worth as much as $16/share, we do not expect investors to value the royalties at that level in the near term given concerns around the imminent share dilution from the offering. We are lowering our 12-month price target to $10 from $13. Recall that our price target is based solely on a DCF of the royalty stream, with a 30% discount to account for a possible disruption of royalty payments in 2010 in the event of prolonged negotiations with Samsung. While our fundamental assumptions with respect to the royalty valuation are unchanged, the value on a per share basis comes down given the share dilution from the offering; hence our price target cut. The key downside risk to our view is failing to renegotiate its royalty; key upside risk is an acquisition.  We are also lowering our CY09 and CY10 estimates. While weak results and guidance were not surprising given the continued deterioration in the economic environment, our estimates are coming down on lower margins and higher taxes: our CY09/CY10 LPS estimates go to -$4.50/-$0.65 from – $0.80/-$0.25 and we are introducing our CY11 estimate of $0.70. We also estimate that the company will burn about $700mn in cash in 2009 even after with a $250mn inflow from the capacity sale to Toshiba in Q1.

Very weak Q4’08 results, with Q1’09 guidance below the Street

NEAR-TERM ENVIRONMENT REMAINS WEAK, WITH SIGNIFICANT OPERATING LOSSES: SanDisk reported Q4’08 revenues of $864mn (+5% qoq), near the high-end of guidance and 12% above our $771mn (-6% qoq) estimate. We estimate that operating LPS (including ESOs but excluding restructuring charges) was -$1.62, significantly below our – $0.29 estimate and significantly below the Street. LPS downside versus our estimate was driven by a significant tax expense ($1.16 per share) vs. our expectation of a tax benefit and a lower gross margin (-38.2% vs. our 14.5% estimate), which were partially offset by higher revenues and lower opex.

The company took significant asset write downs during the quarter, with a goodwill impairment charge totaling $1.02bn. Additionally, SanDisk incurred $388mn in charges in the gross margin line comprised of an inventory write down, charges associated with recent production cuts, and an impairment charge related to SanDisk’s fab investments with Toshiba. As a result, while Q4’08 revenues were better than expected as megabytes sold increased 49% qoq, product gross margin was extremely weak at -61% in Q4’08.

Q1’09 revenue guidance was significantly below the Street at $475mn-$575mn (-33% to – 45% qoq) versus the Street at $627mn. While gross margin guidance was not provided, we believe that product gross margins could be as low as -40% to -50% in Q1’09, driving significant incremental losses. We are revising our CY09 and CY10 estimates downward given the significant margin compression and incremental tax expense and estimate that SanDisk could burn as much as $700mn in cash in 2009 even after receiving about $250mn from Toshiba in Q1 from the capacity sale. Our CY09/CY10 LPS estimates go to -$4.50/- $0.65 from -$0.80/-$0.25 and we are introducing our CY11 EPS estimate of $0.70.

HOWEVER, CAPACITY CUTS ARE ENCOURAGING AND WE CONTINUE TO EXPECT A SUPPLY/DEMAND BALACE IN 2009: While the near-term environment remains challenging, we are encouraged by the magnitude of capacity reductions being implemented by the NAND makers and expect NAND supply demand to come into balance in 2H’09. SanDisk’s management indicated that the company’s bit supply will grow at under 50% yoy versus in excess of 100% in 2008 and we expect industry supply growth to be even more moderate in 2009 in the 40% range. We believe that the capacity reductions are already beginning to get reflected in memory pricing with commodity and retail card prices up significantly over the last several months (see Exhibit 1 below). While SanDisk’s prices remain weak for now, in part due to the company’s longer terms retail contracts, we expect pricing to improve toward the end of the year, as excess capacity gets rationalized.

WE CONTINUE TO LIKE SANDISK’S ROYALTY STORY, BUT DILUTION FROM THE IMMINENT EQUITY OFFERING LEAVES US ON THE SIDELINES FOR NOW: There is no change to our view that SanDisk retains some of the key IP in the NAND industry, which we believe could be worth significantly more than what is implied by the current stock price. While we believe that SanDisk’s royalty business could be worth as much as $16/share, we do not expect investors to value the royalties at that level in the near term given concerns around the imminent share dilution from the offering. We are lowering our 12-month price target to $10 from $13. Recall that our price target is based solely on the DCF value of SanDisk’s royalty stream, with a 30% discount to account for a possible disruption of royalty payments in 2010 in the event of prolonged negotiations between Samsung and SanDisk. While our fundamental assumptions with respect to the royalty valuation are unchanged, the value on a per share basis comes down given the share dilution from the offering; hence our price target cut. Key downside risks to our view include failure to renegotiate its royalty with Samsung and a prolonged memory downturn. Key upside risks are significant margin improvement and an acquisition.

**** JP Morgan Excerpts below ****

JP Morgan

Price:  $11.28
Price Target: $5.00
Underweight

Paul Coster, CFAAC
Mark Strouse
J.P. Morgan Securities Inc.

Sandisk Corp
Mixed 4Q Results, Guidance Disappoints; Adj Ests

SNDK reported mixed 4Q results as stronger than anticipated revenue was offset by deteriorating margins. 1Q guidance was disappointing, and the company conceded poor visibility into 2H09. We believe that a slowdown in licensing revenue could be the next shoe to drop. The company is committed to managing the balance sheet and has left open the possibility of an equity raise in order to provide a cash cushion during FY09. We are trimming our ests but maintain our $5.00 Dec 2009 price target.

• Mixed 4Q results. SNDK reported strong 4Q revenue of $863.9mm, ahead of consensus estimates of $766.7mm (JPMe: $729.1mm), owing to solid retail sales. OEM sales were lower than expected owing to weak handset vendor demand. PF gross margin was (60.5)% due to $388mm in inventory charges, idle capacity costs, and impairment charges.

• 1Q guidance disappoints. SNDK looks for 1Q revenue of $475-575mm, below consensus estimates of $631.7mm (JPMe: $558.7mm). Weakness in OEM sales is expected to continue while retail sales will also slow. PF gross margins are expected to be negative again, although better than 4Q margins. The company is committed to reining in expenses during FY09, with PF opex expected to decline 17% y/y. We are trimming our estimates accordingly.

• Possible equity raise. SNDK re-filed a shelf registration and indicated that a$300-500mm equity raise could occur in FY09. Such an offering would be approximately 16% dilutive. Proceeds from the offering would be used as a buffer for SNDK in case the economic downturn lasts longer than anticipated.

• Licensing thoughts. We believe Samsung is beginning to move to 3-bit per cell production using in-house technology. In doing so, we believe Samsung will enter licensing contract discussions with SNDK with a stronger negotiating stance. We are trimming our y/y licensing growth to (10)% in CY09 and (5)% in CY10.

Maintain Underweight. We expect SNDK to underperform the mean of our coverage owing to a period of net losses and negative operational cash flow. Our December 2009 price target remains $5.00, based on a multiple of 12 times CY10E PF EPS of $0.40. The multiple is close to an historical trough for SNDK, justified by uncertainties of the NAND space and what we view as a protracted demand slump.

Valuation and Rating Analysis

Maintain Underweight. We expect SNDK to underperform the mean of our coverage owing to a period of net losses and negative operational cash flow. Our December 2009 price target remains $5.00, based on a multiple of 12 times CY10E PF EPS of $0.40. The multiple is close to an historical trough for SNDK, justified by uncertainties of the NAND space and what we view as a protracted demand slump.

Risks to Our Price Target and Rating

Our price target is at risk from a broad re-rating of risk premiums for the stocks we have under coverage.

We could become more constructive on SNDK’s prospects for any of the following reasons:

• Overall NAND capacity is reduced either through competitors retiring production capacity or leaving the industry altogether

• SNDK renegotiates its current licensing agreements quicker than anticipated and/or at better terms than the market currently expects

• SNDK produces SSDs on 43nm/X3 or X4 and sub 40nm technology that breaks through new price points, spurring elastic demand (assuming a solid controller accompanies the product)

• SNDK realizes further cost savings (on either memory or non-memory costs) that enable it to expand margins

• SNDK makes 3D memory commercially available in large scale, creating a sustainable competitive advantage through patent-protected cost leadership.

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