Monetizing IP

This week I thought it would be interesting to look at SanDisk’s IP revenue breakdown. In 2008 Sandisk collected $508M in license and royalty revenues, accounting for about 15% of total revenues.

Long term, SanDisk has said that it is targeting license and royalty revenues to be 8 to 10% of sales.

SanDisk won’t comment on the pieces of its IP-related revenue, but the breakdown is probably still in line with the percentages outlined in Citi’s report from back in February of 2008.

After all, Citi’s 2008 estimate of $503M total came mighty close to the actual $508M. Citi’s 12 February 2008 SNDK royalty revenue estimates are shown below:

0212-citi2

Citi breaks license and royalty revenues into 5 catagories: Samsung, Hynix, Other Manufacturing Licenses, SD/ Micro SD Card Licensing, and CF/ USB Drive Licensing.

It is unclear, at least to me, what Citi  included in Other Manufacturing Licenses. They never said. Toshiba for 3D R/W needs to be accounted for somewhere. This would seem as good a category as any.

Samsung

Uncertainty over a Samsung re-sign has been a drag on SanDisk’s share price for well over a year, and rightly so.

Samsung represents by far and away the largest piece of SanDisk’s IP revenue. In 2008 this was likely between $350M and $400M, or between 70% and 80% of royalty revenue.

I still believe that Samsung will re-sign, though at lower than current rates, before the current deal expires in August.

The turning point likely came in May 2008 when Samsung lost its rights to msystems IP beyond 2009.  SanDisk now owns this IP and continued use by Samsung will require a re-sign.

In the arbitration Samsung argued that if it were to lose (which it did), it would have to license this IP from SanDisk. Apparently Samsung said this could cost “billions of dollars.” From the final arbitration award:

“According to the testimony at the hearings, an early termination of the license caused by a termination of the Strategic Agreement will have serious financial consequences. This is due to M-Systems announcement in the second quarter of 2006 of a technological breakthrough called x4 technology, which enables, for the first time, the use of 4 bits per cell NAND. This effectively doubles the capacity of the 2 bits per cell NAND technology now utilized in flash memory products. According to the testimony, this new technology has significant implications for personal computers and all entertainment devices. The timing of M-Systems Notice of Termination did not escape Samsung who argues strenuously that, without the license granted under the Strategic Agreement, it will only be able to acquire the rights to the new x4 technology through a renewal or extension of its existing technology cross-license with SanDisk. According to Samsung, SanDisk will use the leverage gained from a victory in this arbitration to force additional royalties that could potentially cost Samsung billions of dollars.”

Shortly after Samsung lost, it tried to acquire SanDisk. Personally I doubt this timing a coincidence.

Hynix

The second largest largest royalty contributer is Hynix, accounting for something like $60M in 2008, up from $30M in 2007.

Hynix and SanDisk signed a patent cross license agreement in March of 2007 which apparently included license and royalty payments. Interestingly, at the time, the centerpiece of the agreement seemed to be x4. There was talk of a joint venture with SanDisk including fab investment from SanDisk in exchange for dedicated capacity.

My guess is that behind the scenes, SanDisk used the Hynix card to pressure Toshiba into an x4 agreement.

As far as I am aware, no Hynix fab investment was ever made by SanDisk. In the Q3 2007 cc Eli wouldn’t even acknowledge a formal fab-investment agreement with Hynix. Eli characterized ongoing discussions only as a “a potential minority investment in one of their (Hynix) 300mm Flash fabs.”

Other Manufacturing Licenses (Toshiba)

I’m not sure we’ll ever know what sort of deal SanDisk cut with Toshiba for x4. I’ve gone over my notes several times. Obviously some meeting of the minds occurred, but I haven’t been able to pin it down.

September 2007 Toshiba was on the outside looking in. At the 5 Sept 2007 CITI conference Judy discussed the x4 IP issues in regards to Toshiba:

“We would expect to produce our 3x technology in our Toshiba joint ventures.  And we have talked about commercializing x4 technology in a joint venture with Hynix. We have significant IP in both of these areas. We haven’t been specific about the nature of  any licenses in those areas.

If possible we could chose to keep some particular new technology to ourselves.”

In October 2008, Toshiba and SanDisk appear joined at the hip for x4. In the Q3 2008 cc, Eli mentions in passing, working with Toshiba for x4. After that comes the joint SanDisk/ Toshiba x4 headline act at the February 2009 International Solid-State Circuits Conference.

Clearly some x4 SanDisk/Toshiba deal has been cut. What exactly, we may never know. I suspect the answer lies buried in the confidential fab agreements. That said, I’m most curious to see whether SanDisk has decided to keep the x4 controllers to itself.

This was msystems’ original strategy- license the x4 chip IP, and then, to keep the game honest, withhold the controller IP. Controllers would then only be available from the mother ship.

The x4 controller then becomes the name of the game. Without the controller, the x4 chips are essentially unusable.

Moving on to 3D R/W, SanDisk SEC filings show that Toshiba and SanDisk have an agreement based on milestones. Toshiba license fees will be based on specific milestones until production, and then royalties on future shipments.

Whether this Toshiba 3D R/W agreement will equal Citi’s $20M/year royalty revenue estimates for “Other Manufacturing Licenses”, I have no idea, but the magnitude feels about right for now. Time will tell.

In the longer run, $20M/year could escalate quickly if SanDisk’s approach to 3D R/W proves itself.

SD/MicroSD Card Licensing and CF/USB Drive Licensing

According to Citi, SanDisk’s SD/MicroSD Card licensing revenues were likely about $25M in 2008. Riding the strength of cards in mobile, this segment was seen as likely to grow to $40M in 2009. Given the recession this $40M is likely to be lower.

CF/USB Drive Licensing was thought by Citi to likely hit $32M in 2009- up from nothing in 2008. Then in 2010, this $32M was expected to double to $64M.

For better or worse, 2010 is not going to happen. 2009 looks dodgy at best.

The problem- SanDisk just lost its ITC case.

When I first heard the news, I was very, very disappointed. Upon further reflection, I’m not sure what more could have been expected.

The deal might have been done when SanDisk withdrew US patent number 5719808 (patent 808) from its infringement complaints in late 2007.

“Among the patents involved in the dispute, the 808 patent is said to be the most complicated and important one. Whether or not SanDisk can show that the companies being sued have infringed on this patent will have a fundamental impact on about 25 related patents, the sources noted.” [Digitimes link no longer available]

That’s going to have to have to do it for now.

One of the curious things about SanDisk is that its IP is valued more by the industry than by Wall Street. Toshiba is taking money that they really don’t have and giving SanDisk cash and forgiving off balance sheet lease obligations because they need SanDisk’s IP.

Last fall, Samsung tried to buy SanDisk for nearly $6 billion ($5.85B) or $26/ share –  largely for SanDisk’s IP.

In March of this year, Goldman Sachs estimated that SanDisk’s royalty stream alone is worth $16/ share:

“However, what we have always found appealing about the SanDisk story was not the company’s product business, but its NAND IP. We believe that SanDisk retains the key NAND patents for both the current and next generation NAND technology (i.e. x3, x4, and 3D), which should enable the company to continue to collect royalty payments from the current and potentially new industry players. We estimate that SanDisk’s royalty stream alone is worth $16/share, significantly above the company’s current stock price [$11.05 on that date].”

Personally I think SanDisk’s IP is worth more than $16 (with a Samsung re-sign) and could be worth much, much more if x3, x4 and 3D prove themselves- along the lines of SanDisk’s patents.

Time will tell.

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10 Responses to Monetizing IP

  1. DanR says:

    Thanks for the informative post.
    ***
    “After all, Citi’s 2008 estimate of $503M total came mighty close to the actual $508M. Citi’s 12 February 2008 SNDK royalty revenue estimates are shown below:”

    Citibank estimates coming close to target were purely incidental because: 1) it was made in 2/08 before Toshiba 3D agreement 2) Was built on Nand revenue increase which did not materialize. I wouldn’t count on Citibank breakdown.

    “Samsung represents by far and away the largest piece of SanDisk’s IP revenue. In 2008 this was likely between $350M and $400M, or between 70% and 80% of royalty revenue.”

    We are all guessing. My guess is just $310M. My guess is based on Samsung Nand adjusted revenue for 2008 of $5,450M (adjusted by excluding Q4-08 and including Q4-07), 6% MLC rate, 3% SLC rate and 90/10 mix. Check: Samsung adjusted revenue in 2007 was higher than in 2008 and yet it didn’t made it for a 10% customer, which means less than $390M in royalties, Not to mention that some of 2007 Samsung related revenue were for MicroSD cards (much more in 2008).

    “Whether this Toshiba 3D R/W agreement will equal Citi’s $20M/year royalty revenue estimates for “Other Manufacturing Licenses”, I have no idea, but the magnitude feels about right for now. Time will tell.”

    As said, the Citi estimate preceded the 3D agreement, so whatever City meant by “Other Manufacturing Licenses” it was not for 3D.

    My guess is $55M. $5M for M-systems cross license agreement with Toshiba and $50M for 3D. I’m basing my 3D estimate on Toshiba ‘Other receivables’ balances prior and after the 3D agreement. I currently believe that Toshiba is paying $25M in Q2 and Q4 for 3D license and around $2.5M in Q3 and Q1 for M-sys embedded patents. Check for 3D: Royalties increased from $129M in Q2-08 to $132M in Q3-08, while Judi at the CC said that the increase was for a new licensee which more than offset decrease in the component based royalties. This fits well for a $12.5M a quarter for 3D license.

    “According to Citi, SanDisk’s SD/MicroSD Card licensing revenues were likely about $25M in 2008.”

    I believe it was much more.
    The SD association charges 6% except from the founders Toshiba, SanDisk, Panasonic.
    Distribution to the SD members based on patent contribution;
    MicroSD whole 6% goes to SanDisk as the SD association adopted the then exiting Transflash SanDisk card; probably SanDisk gets nice chunk on the SD cards too. For MicroSD, SanDisk said it sold 140M cards and they probably have just 50-60% of WW sales, so my guess is that just the MicroSD cards royalties could amount to $50M or so. Now imagine the royalties if the Mobile attach rate would come close to that of the DSC attach rate. No wonder SanDisk is pushing hard all kinds of MicroSd uses.

    “Shortly after Samsung lost, it tried to acquire SanDisk. Personally I doubt this timing a coincidence.”

    I agree X4 is the key.

    “My guess is that behind the scenes, SanDisk used the Hynix card to pressure Toshiba into an x4 agreement.”

    Good catch.

    “That said, I’m most curious to see whether SanDisk has decided to keep the x4 controllers to itself.”

    They did. See the X4 PR from SanDisk. In a retrospect that might explain the good catch I was referring too.

  2. medda says:

    I think Sammy is ready to sign after seeing the SPSN litigation resolved. Im going into this week’s earnings thinking we could see a deal as early as this month, yes, potentially on earnings. SNDK has a limited window to get things right in order to raise equity in the mkt. supply has been in Sndk’s favor, demand has stabilized esp on the mobile side, 40% of sndk revs, Samsung seems willing to settle with their IP concerns and SNDK knows they price increases they’ve passed thru the channel is perfect to get Wall St excited and add a Sammy settlement. Let’s see how we play out this month

  3. savolainen says:

    Hey Dan,

    Thanks for comments.

    I agree, Citi is not to be relied upon. I thought it an interesting starting point though. At least they tried.

    In the Q4 2007 cc a couple of weeks prior to the Citi report, SanDisk guided $450M to $500M for license and royalty for 2008. Citi probably picked the high end knowing SNDK’s conservatism and then worked the pieces to fit.

    You make a convincing argument for Samsung being less than $350 to $400M. I agree with your 3% SLC and 6% MLC rates for the current agreement. I’m expecting about 50% of these with a new agreement. I suspect both Samsung and SanDisk can live with that.

    My guess is that the tough negotiations are over X4 and 3D R/W. Also the other msystems’ IP has be sorted out. FLSH IP could cost Samsung dearly.

    One high volume/ high margin product family in particular comes to mind. Samsung copied its fusion differentiated NAND products (such as OneNAND) from msystems.

    Samsung shipped over 100M OneNand units in 2006. Today this has to be much higher. I thought this November 2008 comment from the Denali blog quite interesting/promising:

    “Samsung has been able to keep its NAND GMs up with ‘fusion’ differentiated NAND products, such as OneNAND (above) Flex-i-NAND and MoviNAND, but these seem to be less than about 10% of GB output.”

    Less than 10% of GB output could still be huge.

    ****

    According to Citi in 2007 “Other Manufacturing Licenses” was $8M and then estimated at $20M each year for 2008, 2009, 2010. The $8M is close to your $5M for Toshiba’s msystems license. So that fits. The remaining $16 for the next three years could be X4, I suppose. SNDK would have had to tell citi. I suppose that could have happened- in rough outines at least. It could also just be a fudge factor on Citi’s part.

    If x4 were also part of the Toshiba IP $50M number, then the 3D R/W payments would be a bit lower. It seems you’ve got the Toshiba total right. And yes 3D R/W did come in June of 2008- after the Citi estimates.

    ****

    I agree that the X4 pr implied that SanDisk might not license the controllers, but it didn’t say that exactly. It said simply that SanDisk alone “owned” the controller.

    Best,
    Savo

  4. paul says:

    savolainen, thanks for this great web page.

    ‘Samsung represents by far and away the largest piece of SanDisk’s IP revenue. In 2008 this was likely between $350M and $400M, or between 70% and 80% of royalty revenue.’

    any thoughts about what would happen to Samsung if SNDK decided not to license X3/X4?

    it would cost SNDK $350-$400M in royalities but allow SNDK to increase production and limit competition. i’m sure the increased production and lower production cost would more than offset the royalties we receive from Samsung.

    comments welcomed

  5. DanR says:

    Savo, regarding the ITC, SanDisk petitioned the ALJ final initial determination on 5/14 – summary uploaded here, worth reading not too techie:
    http://www.docstoc.com/docs/6364349/Sndk-ITC-337-619-pet

    Lately, the commission has overruled the ALJ ID of non infringement in the TSRA case against certain wireless companies.

    If the commission accepts the petition than there is good chance for reverse ruling. The decision (review Yes/No) is expected on 6/22.

    One can view the ITC documents here: IN: 337-619
    https://edis.usitc.gov/edis3-external/page.svc?page=edis3Search%3AAdvancedSearch

    I’m quite sure that the commission will overrule item 17 of the 424 patent because the ALJ decision based on the ‘page’ definition was just idiotic. However, that will be relevant only to some of Phision controller, and it is not that essential. The main issue in the petition is the 24-30 items of the 424 patent which is relevant to all controllers and is quite fundamental. I think that SanDisk presents good argument here too, but this could go either way. Lastly, I don’t really care for the 011 patent which really involve only the Memorex controllers.

    SanDisk lost important milestone, but it’s not over yet.

    • savolainen says:

      Hi Dan,

      Thanks for the comment and link. When I have more time in the next couple of days I will read through it all. Soon I will need to go out back, fire up the grill and burn some hot dogs and hamburgers- Its a holiday here in the USA.

      ****

      Back to microSD. I was expecting Eli to say something about MicroSD at JPMorgan, but he didn’t- even when given the opportunity.

      I’m sure you noticed Dan Amir’s 4 June 2009 comments:

      “SanDisk microSD cards output is very strong. Based on our checks, SNDK’s daily shipments of microSD cards are up to 1.8M vs. 1.3M/day last quarter. We believe most of the demand is still coming out of the China handset market and the increasing amount of smartphones entering the market.”

      1.8M cards a day from SanDisk alone is huge and 38% over Q1 is also remarkable growth- especially given these times.

      I have gone back through my notes on microSD. In the Q3 2008 SNDK cc, Eli said that 770M handsets were expected to be sold in 2008 with a slot for microSD or M2 card.

      Back in February 2008 citi thought SanDisk had an 85% marketshare in retail.

      Last quarter, OEM seemed to be driving SanDisk’s microSD sales. Sales to mobile network operators in particular were noted as significant in the Q1 2009 cc.

      In your last comment on microSD you said, “ SanDisk said it sold 140M cards [2008] and they probably have just 50-60% of WW sales, so my guess is that just the MicroSD cards royalties could amount to $50M or so.”

      Are you comfortable with D Amir’s numbers which would imply upwards of 600M microSD cards for SanDisk alone in 2009? And if this is just 50 to 60% of WW sales, WW sales of microSD for 2009 could be upwards of 1.2B microSD cards?

      Best,
      Savo

  6. DanR says:

    Amir’s numbers seem excessive.

    In 2008, SanDisk sold 175M mobile cards (Mostly MicroSD but also M2 cards for SNE and MiniSD) {Q4 CC}

    The run rate in Q1 was probably 40-45M cards. SanDisk said that Mobile revenue comprised around 35% of all product revenue, which make for an average selling price of ~$4 per card.

    1.8 MicroSD cards per day or more than 150M cards in Q2 is more than $600M in revenue for MicroSD cards alone. Doesn’t make any sense.

    What was nice in Q1 is that average density rose very significantly in the OEM channel. That was not due to mobile vendors bundling, but more of the mobile operators buying and promoting the use of high density cards.

    I recall, if I’m not mistaken that it was on the Q3 07 CC, Eli was bragging on SanDisk shipping more than 1M cards per day. It could be that SanDisk is shipping now 1.3M cards per day. Not just MicroSD card.

    A 38% unit increase Q/Q seems excessive as well.

    My guess is that we’ll get a 10% price increase per card and 10% increase in the total number of unit sold and this estimate is already fairly aggressive relative to current street estimates. It seems that the constant factor is the price increase as SanDisk top priority is returning to profitability and the variable is the demand. So far, it seems that the price increase was relatively well received.

    For mobile, the attach rate is still low (25-30%), so out of the -800M slotted phone only 200-250M users actually make use of their mobile slot. Now that I look at the numbers, it seems that SanDisk market share is probably higher than I previously thought ~ 70-75%. The trend of more and higher featured phones is quite encouraging though.

  7. Poofypuppy says:

    Hi Savo,

    How well did SanDisk monetize its IP with the just-announced Samsung renewal agreement? I guess my biggest question is, what did Eli put in the contract to ensure that Samsung does not renege on guaranteed supply agreements as they did to M-Systems several years ago?

    Regards,
    Poofy

  8. savolainen says:

    Hi Poofy,

    I am very happy with what we know of today’s news. Can we get an analyst day now?

    D Amir’s LCM comments this AM were interesting. I have been figuring that current Samsung royalty rates on NAND at 6%±. Amir implies they are 8%- which would make the new rate 4%. Not bad, everything considered. Also there should be more products licensed (FLSH IP), which should add a bit.

    I am not so worried about the third party supply angle. Hopefully SNDK has themselves covered. Also when SNDK starts needing this supply, I am guessing their first source will be Toshiba. Though the additional supply from Samsung could come in handy with SSDs down the road.

    It seems like SNDK and Samsung couldn’t reach an agreement for 3D and decided to let that ride until later- which does make a certain amount of sense.

    Best,
    Savo

    From LCM this AM:

    “SNDK: Samsung renews license deal – uncertainty removed

    SanDisk and Samsung have renewed their license agreement at half the previous rate. Today, SanDisk and Samsung agreed to renew the cross-license agreement regarding their semiconductor patent portfolios at a rate of ~4%, slightly below our expectation of 5% but higher than Street expectations. The new patent cross-license agreement includes rights to each party’s patents covering multi-level cell flash memory and flash storage systems. The agreement does not include either party’s patent claims regarding 3-D memory technology.

    Additionally, the companies signed a supply agreement. We view this positively for SanDisk. Under the flash memory supply agreement, Samsung will continue to make available to SanDisk a guaranteed portion of its flash memory production output. The new agreements become effective when the current cross- license and supply agreements expire on August 14, 2009, and will run for seven years from that date.

    We will update our model following the conference call.

    We are currently modeling a 5% licensing rate, which we expect will be lowered to 4%, reducing our 2010 numbers by ~$50 million.

    Overall, positive news. The agreement removes uncertainty that has hovered over SanDisk’s story and should give investors more clarity with regard to SNDK’s long-term business model and prospects. We believe that sentiment will now turn much more positive with this event.”

  9. Poofypuppy says:

    Hi Savo,

    Do you have any thoughts regarding the impact of the U.S. International Trade Commission’s finding of “no violation” of SanDisk’s patents?

    http://www.bloomberg.com/apps/news?pid=20601103&sid=aQRT.D2BCEJs

    Thanks,
    Poofypuppy

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