Lazard

A friend passed along the SanDisk Lazard report which caused such a commotion last week. Thought some folks out there might be interested. Excerpts are posted below.

Included is some interesting detail that hasn’t been mentioned in the press. Most notably, Dan Amir thinks SanDisk’s product gross margins are going to swing back positive for Q2- a quarter early.

While the dollars involved are not huge, $10M here and $10M there, can add up to real money. There is tremendous leverage in the cost/price balance – or lack thereof.

Its been three + years of lack thereof. Now that just about everyone has given up, ironically the pendulum comes swinging back.

If the pendulum continues it’s swing back, SanDisk just might surprise us all.

A ways to go from here though. The next big test will be in the 2H, when idled capacity comes back on line.

According to Amir, there is currently a component supply shortage in the market. Toshiba has cut production more than 30% and anticipates cutting an additional 10% in coming weeks.

Amir also says MU/INTC has quality issues at 32nm, contributing to the supply bottleneck. As the link above indicates, Amir apparently hit a nerve with that one. To my mind IMFT doth protest too much.

My guess is that Amir is right, and that the quality issues revolve around MLC. The timeframe fits, and multilevel issues can be expected at this node.

Amir feels that the NAND market is starting to find a bottom, and 2009 should be a better year in terms of pricing. We shall see.

All the way down, SanDisk’s stock has remained tightly coupled with contract NAND pricing. Now that prices are up, suppose its not too much of a surprise that the stock is showing some resilience.

One angle probably contributing to the supply shortage, not mentioned by Amir, is reported buying by Apple for product refresh, as well as rumored new product lines.

An updated 32GB iPhone refresh seems almost a given. An iPhone Nano seems logical enough as a new product. Most interesting could be the rumored Apple Netbook Touchscreen. Such a product would seem a natural for a NAND SSD.

Clearly the more NAND Apple soaks up, the less supply there is for everyone else. When supply gets tight, and Apple is buying, all the better for SanDisk.

Thanks to prepaid supply guarantees signed back in 2005, Apple likely steps to the front of the line- probably at best prices. This dynamic could be most interesting at times like these, when supply is actually shrinking.

I suspect that the big NAND players (other than SNDK) were counting on ever increasing supply when they inked their deals with Apple. Today with shrinking supply, I have no doubt that Apple will continue to get theirs- which not only will mean less supply, but also fewer options/less profit for their NAND suppliers.

**** Lazard Excerpts Below ****

SanDisk

March 10, 2009

SNDK: Retail pricing moving up; positive GM impact for 2Q;
UPGRADING to BUY from HOLD, $12 price target  Semiconductors
Recommendation Change

Daniel  Amir
Lauren  Stoller

SanDisk raising card prices. In recent days, we have learned that SNDK is starting to increase card pricing to distributors as much as 15% for 2GB and 4GB MicroSD cards. We believe that SNDK retail card prices, which currently sell at a 20% discount, will likely see an increase of 10%-15% in coming weeks as SNDK begins to raise pricing to retailers. Card inventory is at less than three weeks.

Component supply shortage in the market. Our checks suggest that Toshiba has cut production more than 30% which it previously forecast and it anticipates cutting an additional 10% in coming weeks. Also, due to quality issues at the 32nm line at MU/INTC, there is a slight component shortage in the market. Industry players expect that NAND component pricing could increase an additional 30%-40% in 2Q, on top of the current 60% move in 1Q.

Yen devaluation should help COGS in 2Q. The devaluation of the Yen to Y98/$1, or 10% since the beginning of 2009, should increase product GM by 2%- 3% in 2Q.

GM strength from SanDisk. Due to SNDK’s business model and its special relationship with Toshiba, SNDK is able to get NAND parts at very low prices. We believe that SNDK’s product GM could be significantly better than current Street expectation for 1Q and especially for 2Q. We are raising our product GM assumptions from –33% and –19% to –29% and +1% for 1Q and 2Q respectively.

Raising EPS estimates. We are raising our estimates for 1Q from $511M/$(0.71) to $511M/$(0.65) and for ’09 from $2,652M/$(1.44) to $2,652M/$(1.11).

Upgrading to BUY with a $12 price target. We are upgrading SNDK because 1) we believe the Street is underestimating the change in the NAND mkt which should lead to better than expected quarterly results; 2) the NAND mkt is starting to find a bottom and ’09 should be a better year in pricing; 3) at 0.5x book, we believe the stock is attractively valued. Our $12 target is based on 0.9x book.  The biggest risk is the extent of the downturn and its effect on NAND mkt dynamics.

INVESTMENT THESIS

We are upgrading SNDK to BUY for the following reasons: 1) we believe the Street is underestimating the positive impact that the changes in the NAND market could have, which should lead to better than expected quarterly results. We believe SNDK’s GM could be much better than expected due to the increasing retail pricing and the better Yen exchange rate; 2) the NAND market is starting to find a bottom and 2009 should be a better year in terms of pricing. We believe the production cuts are fairly significant and further cuts could come out of Toshiba; 3) at 0.5x book, we believe the stock is attractively valued.  Our $12 price target is based on 0.9x book, in line with the average historical multiple for the memory group.

INVESTMENT SUMMARY

Upgrading to BUY. While this might be an early call, as the full impact of SNDK’s retail price movement will not be realized until 2Q, we believe that the company’s profitability could improve much more than the Street expects in the short term. We believe positive movements in both contract pricing and retail pricing in the next few weeks will favorably affect SNDK’s GM and earnings in the next quarter. In our view the Street’s expectations are low currently and therefore we expect management’s April conference call to positively surprise.

SanDisk raising card prices. In recent days, we have found that SNDK is beginning to raise card pricing to distributors by as much as 15% for the 2GB and 4GB MicroSD cards. We believe that the company’s retail card prices, which currently sell at a 20% discount, will be increased by 10%-15% in coming weeks, as SNDK begins to roll out higher prices to retail distributors. There tends to be a requirement of 60 days’ prior notice for price increases, hence we believe the new pricing will not occur until April or May. We believe that the current 2GB MicroSD card that SanDisk is selling for $3.75 should be closer to $5, which leaves significant room for upward price movement in our view.

Component supply shortage in the market. Our checks suggest that Toshiba has cut production more than the 30% it had previously forecast and it anticipates cutting an additional 10% in coming weeks. Furthermore, due to quality issues at the 32nm line at MU/INTC, there is a slight component shortage in the market. Industry players expect that NAND component pricing could increase an additional 30%-40% in 2Q, on top of the current 60% move in 1Q. Current prices currently quoted by Samsung are as much as 20% higher than those by Micron for a 32Gb component, which suggests that contract prices should be moving up in the next few weeks.

Yen devaluation should help COGS.  The devaluation of the Yen to Y98/$1 or 10% since the beginning of ’09 should increase product GM by 2%-3% in 2Q. In 2Q08, we saw a negative impact of 4% SNDK’s product GM due to a 9% devaluation of the Yen in 1Q08. We therefore see the current level of depreciation as a potential positive catalyst for the company’s GM next quarter.

Samsung license deal in the works. While the risk remains that Samsung might not renew a licensing deal, we believe the likelihood of that happening is low. Our checks show that Samsung is interested in a deal that would give it access to X3 and X4 and would also accelerate the time to market of these products. We believe that a deal is most likely to occur in late 2Q, at reduced terms. We believe that the Street is already expecting lower revenues from Samsung and therefore any announced deal would be a positive one.

Raising EPS estimates.  We are raising our GM and EPS estimates for 1Q from –33% and $(0.71) to –29% and $(0.65) and keeping our revenue estimate of $511M.  For 2Q we are raising our GM from –19% to 1% which drives our EPS estimate from $(0.53) to $(0.25) on the same revenue of $571.7M.  For FY09 our revenue estimate remains unchanged at $2,652M but our EPS estimate goes from $(1.44) to $(1.11) on GM of –1.9%.

Where we could be wrong: 1) An equity deal could happen sooner than expected, which could dilute shareholders by 15%-20%; 2) price increases could still result in SNDK shipping product below its costs; 3) a lack of demand in the market could negatively affect its top line if SNDK raises prices.

lazard

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