Monetizing IP- Updated

This week I thought it would be interesting to revisit SanDisk’s IP revenue breakdown in light of the new SanDisk/Samsung cross license agreement.

As discussed in 2008 Sandisk collected $508M in license and royalty revenues, for about 15% of total revenues.

To my knowledge, SanDisk has never publicly commented on size of its individual IP royalty streams- at least until now. In the Samsung agreement analyst call [transcription] SanDisk stated that for the last several years Samsung contributed approximately two-thirds of of SanDisk’s royalty revenue.

This means that in 2008, Samsung paid SanDisk approximately $335M. About $63M less than citi’s estimate of $398M. So now there is $63M to redistribute for 2008.

SanDisk’s IP revenue streams can be broken into: Samsung, Hynix, Other Manufacturing Licenses, and SD/ microSD/ CF/ USB Drive Licensing.

$60M for Hynix still seems about right, so I am choosing to allocate the “extra” $63M ± between Other Manufacturing Licenses and SD/ microSD/ CF/ USB Drive Licensing.

My updated working breakdown for 2008 SanDisk license and royalty revenues now looks like this: Samsung- $335M or 66%; Hynix- $60M or 12%; Other Manufacturing Licenses- $20M + $33M = $53M or 10%; and SD/ microSD/ CF/ USB Drive Licensing- $25M + $30M=  $60M or 12%.

Samsung

Say what you will about the new Samsung agreement, but its done now and that alone is a relief. In the big picture, it feels like a win-win for both SanDisk and Samsung. Compromises all around, but such is life.

Several things about the agreement were learned from the conference call.

First it is two agreements. There is a new patent cross-license agreement which contains both running royalties as well as certain fixed payments to SanDisk. There is also a flash memory supply agreement under which 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 agreement expires on August 14, 2009, and will run for seven years.

A key sentence from the the press release:

“Over the life of the new license, the estimated effective rate of the fixed payments and royalties is expected to be approximately half of the effective rate in recent years under the current license.”

This drop is in line with expectations. Eli has been saying as much for a while now.

The new patent cross-license agreement covers MLC and flash storage systems, but not 3-D memory technology. MLC includes any number of bits including X4.

Whether X4 controllers are covered and whether X4 rates are the same as X2 and X3 remains to be seen. To my mind the conference call left these questions open.

Time will tell how important the flash memory supply agreement will be. I found the following discussion from the conference call very interesting:

“Scott Hurlman, Robert W. Baird: Okay, and then, does this have any impact on future CapEx plans for this year or next?

Eli Harari: To the extent that we take advantage of that guaranteed capacity that it is competitive then it definitely should have quite substantial reduction in the requirements of our CapEx that’s – that’s what I’m talking about in terms of giving up that flexibility to move to our captive/non-captive mix.

Scott Hurlman, Robert W. Baird: Right.

Judy Bruner: But I would add as Eli said we are not currently in need of non-captive, and our CapEx budget for this year is not impacted.

Eli Harari: Is not impacted. And basically the whole point with these guaranteed capacities is that when you have excess supply you don’t need that capacity. When you have – where you have allocation when we have shortage that’s when you need it, and it’s very important to have that capacity guaranteed to you. However, you can have it guaranteed, but if you are not actually exercising it, if you are not qualified to use it I mean, internally qualified and with your own customers, then there is a significant lag time before we can bring it on board.”

A couple of years from now, this supply agreement could prove most valuable in the NAND endgame.

As Eli put it recently, in five years the NAND business is going to hit a brick wall.

I keep wondering what the CapEx dynamics will be when the technological dead end is in sight. Supply agreements might give Sandisk a prudent alternative to big dollars for a last gasp. Better to spend the money on putting the finishing touches on the successor technology.

Hynix

I still believe Hynix, accounted for something like $60M in 2008.

My thinking is that the new Samsung agreement is now in line with SanDisk’s Hynix agreement.

The new Samsung agreement is half of what it was- which would mean that in 2008 Hynix paid at about half the rate of Samsung.

This checks with market share by revenue.

According to the DRAMeXchange, in 2008 Samsung had about 40% of the NAND market, while Hynix had about 15%. The total NAND market was $11.4B or so. Samsung’s share was about $4.56B, while Hynix accounted for about $1.71 B.

In 2008, we now know Samsung paid SanDisk approximately $335M or about 7.5% of its NAND revenues. If Hynix only paid at half that rate, say 3.25% on $1.71 B, Hynix would have paid SanDisk $56M. Close enough so I’m still going with $60M.

Toshiba Manufacturing Licenses

Last time around I guestimated Other Manufacturing Licenses (Toshiba) at $20M. This was probably low. I’m now going with $53M or about 10% of IP revenues.

This $53M is likely made up of deals cut for X4 and 3D.

I’m not sure we’ll ever know what sort of deal SanDisk cut with Toshiba for x4, but something happened and that something probably involved $. 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.

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

Last time around DanR thought I was low in my estimate of $20M. I think he was right.

As he put it:

“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.”

SD/ microSD/ CF/ USB Drive Licensing

I’m also upping the estimated revenues from this segment to $60M or 12% of IP revenues for 2008. $60M feels high, but I believe I have been underestimating microSD.

I finally tracked down some reliable numbers for microSD in 2008: 397M microSD cards shipped according to a recent Garner report. In the Q4 2008 conference call, Eli noted that SanDisk sold 175 mobile cards. Some of these were M2 for Sony.

I wasn’t able to obtain microSD market or market share by revenue. If anyone out there has these numbers, they would be most appreciated.

In any case, it looks to me like SanDisk had roughly 40% of the 2008 microSD market- at least by units shipped.

The other 60% of the market should have been paying royalties at a likely rate of 6%. I have no idea of what percentage of this 6% was SanDisk’s. Some feel SanDisk gets it all. This could very well be true. After all SanDisk developed the format.

The microSD story deserves its own post. It is becoming a very interesting and potentially significant story. A de facto standard in a booming market.

Gartner is estimating the microSD market for 2009 to be 435M units- a 10% increase over 2008.

Micron

Now that SanDisk has signed Samsung, the question is whether it will go after Micron.

SanDisk has said that it feels Micron needs a license. Micron feels otherwise.

Micron’s NAND business is part of a joint venture with Intel known as IMFT. Intel is covered by it’s cross-license agreement with SanDisk. The $29M question is whether Intel’s presence in the JV gives Micron the necessary IP cover.

This is clearly a lawyerly question and one that only the courts can answer.

It just so happens that Jim Brelsford, SanDisk’s General Counsel, has a background in just such JV IP issues. Read into that what you may.

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10 Responses to Monetizing IP- Updated

  1. Poofypuppy says:

    Thanks Savo,

    Great info as always. You bring up a very good point about the supply agreement with Samsung potentially saving SanDisk a lot of CapEx dollars when the [Moore’s Law] 2D node shrinks reach the end of the road. It would certainly be interesting to know how much supply is guaranteed and at what terms/price, and I trust that SanDisk will make sure that Samsung delivers on its supply commitments when they are needed the next time around.

    Regards,
    Poofy

    • savolainen says:

      Hey Poofy,

      I hear you about Samsung and its supply agreements. I would hope that SanDisk has learned from FLSH’s experience and has as many angles as possible covered contractually.

      Apparently Samsung has committed to supplying SanDisk a portion of its flash memory production under “competitive” terms- “competitive with the market”. My understanding from the call is that competitive means at prices comparable to what others are paying. I would hope that this means that no one else is going to get Samsung flash cheaper.

      I don’t think SanDisk is slated to be get better pricing than Samsung’s best customers.

      The agreement is based on SanDisk’s needs. SanDisk is not obligated to take any flash until a purchase order is in place, then Samsung has a commitment to fill that order and SanDisk has a commitment to take the order.

      Eli emphasized that SanDisk needs to start taking advantage of the Samsung supply or it will atrophy. He was pointing out that products using Samsung flash will need to be qualified with customers and so forth and this takes time.

      My guess is that SanDisk will start using Samsung flash next year- 2010.

      I was really surprised today when Sanjay said that it was unlikely that SanDisk would be adding new wafer capacity in 2010.

      This could be interpreted several ways. Maybe 24nm is shaping up as particularly challenging. Maybe real progress is being made with 3D. Maybe 32nm, X3, and X4 will add enough bits to keep pace with demand- when supplemented with third party flash.

      Maybe all of the above. I think Eli was right- the game has changed fundamentally. This endgame could have entirely different dynamics than those we’ve gotten used to over the last five years. Time will tell.

      I found today’s announcement that Apple is including an SD slot on its new 13” notebook very curious and very out of character. Is this the beginning of a trend that could end with microSD and the iPhone?

      And why now? Maybe Apple is exploring options and preparing for the days when NAND isn’t so readily available or relatively inexpensive. Apple could also be prepping for software distribution (others) via SD or something else altogether. Inquiring minds wonder why?

      If you didn’t notice, I posted a transcription of the Samsung agreement call.

      Best,
      Savo

  2. Sam says:

    The x4 controller issue was not covered in the CC, as you say–I don’t know exactly why no analyst asked specifically about it, but whatever. I spoke IR last week and asked them about it, and whether Sandisk planned on following mSys’s lead in making money on x4 by giving the chips away but selling the controller. He confirmed that that was the plan. I know that the chip itself is useless without the special controller (which presumably is covered by patents), but I am not clear about how that will work. Can we think of the controller as analogous to an HD head, sold separately, and then assembled with the chip in a final process? I’m just throwing that out there.

    Thanks so much for your commentary, I love reading it.

    • savolainen says:

      Greetings Sam,

      Many thanks for passing along SanDisk’s IR comments on the X4 controller.

      I’m not sure exactly what you are wondering about. As I understand it, at least what FLSH had planned, was to license the X4 chips, so that other’s could make them. In exchange FLSH would have gotten royalties and best priced supply.

      Just like SanDisk appears to be planning, FLSH was going to keep control of the controllers. I don’t think the idea was so much to make a ton of money (though some) on the controllers, but rather to keep the licensees honest. In other words, licensees wouldn’t be able to fudge numbers. The number of chips on which they owed royalties would equal the number of controllers they needed. An X4 chip without an X4 controller is junk.

      Although FLSH never talked about the details of their strategic X4 planning, I suspect the idea was also to maintain a moat around the critical IP. In other words, if specific IP (controllers) was never licensed, there would be less likelihood of competitors being able to claim later on that somehow they had been given open-ended access- forever more.

      Your analogy of the HD head is probably accurate, if you throw in the mind-boggling complexities of this technology.

      I believe the key idea is that groups of flash memory cells can store information above and beyond the information stored in the flash memory cells themselves. With a few twists, a top-up in memory capacity is possible for “free.” This fundamental technology is original.

      This fundamental technology isn’t 4 bit/cell specific, but we haven’t seen or heard of other applications- yet.

      Curiously SanDisk consistently seems to play X4 down. Whether this is a clever (disingenuous) strategy or simple honesty remains to be seen.

      Eli and Sanjay seem to always sound barely interested- So it was a bit shocking when Samsung (apparently) made such a big deal of X4 in the FLSH arbitration they lost to SanDisk last year.

      At the time I thought it telling that Samsung did everything in its power to keep its own testimony from becoming public. From what we did hear Samsung thought that licensing X4 could cost it “Billions.”

      I suspect that there was more to the Samsung testimony that it didn’t want revealed. I suspect that much of Samsung’s NAND technologies are based on FLSH patents- which are now owned by SanDisk.

      The big knock on X4 was that it was slow and not reliable. Dov used to say that he expected it would just get better and better over time.

      The slow seems to have been taken care of already. Write speed took a rather large jump at the end of last year. X4 @43nm jumped from 5.6MB/sec to 7.8MB/sec on software alone.

      X4 must be very interesting. Some “Optimization” and the speed jumps 40%.

      I’m hoping that just like speed, reliability issues will be sorted out eventually. As no doubt you are aware, initially SanDisk will only be shipping X4 in certain limited applications such as its blue label cards.

      Dov Moran said that as X4 matures he expected it to be used in just about all applications: memory cards, USB flash drives, embedded flash data storage, and even SSDs. I’m not holding my breath over SSDs, but performance/reliability suitable for other less demanding applications would be nice to see.

      Regards,
      Savo

  3. starsdude says:

    Is there any indication that there was asettlement on the Trade ruling won by Samsung-does anyone know what the potential payoff could be

  4. starsdude says:

    Sorry meant ruling against Samsung by Sandisk

  5. medda says:

    SAVO,

    I think you’re missing the most important piece to the IP puzzle. Actually, you’re not the only one, the whole investment community may be overlooking what SNDK has put into action 2 yrs ago which i think comes into play this yr or early next yr. Sandisk formed what seems to be a patent troll company called solid storage solutions(something like that). I think M-systems SSD patents will come into play here. When the market is ripe sndk will come to get their vig.
    Do some homework here, but no one has ever asked management a question on this piece of news going back to sept/oct 2007 when they released it in their SEC forms.

  6. Poofypuppy says:

    medda,

    Savo commented on Solid State Storage Solutions last year in this post…
    https://savolainen.wordpress.com/2008/12/07/more-x-files/

    Regards,
    Poofy

  7. DanR says:

    Savo, the SD royalties and especially the MicroSD piece is a hidden gem that is often overlooked by most analysts. It certainly deserves a separate post.

    Here is a link which details market share for all cards.
    http://www.digitimes.com/news/a20090615PD210.html

    ” Around 270 million SecureDigital (SD) flash memory cards were shipped in 2008, of 100 million shipped were 2GB products, said iSuppli. microSD card shipments totaled 397 million units last year, of which 128 million were 2GB cards followed by 131 million 1GB ones.
    Combined shipments of SD, miniSD and microSD cards totaled more than 700 million units in 2008, far surpassing those of CF, MMC and MS cards, according to iSuppli.”
    I’ll add to your post that 1) Toshiba and Panasonic, as co co-founders of the SD association, do not pay royalties (as well as SanDisk) 2) royalties to SanDisk from the SD association are probably 2-3% for SD cards and 4-6% for MicroSD cards, all out of the 6% that the SD association charges. 3) SNE is moving recentaly, in its latest models, to the MicroSD format 4) The SD association is ready for an embedded SD based format, which is probably based on SanDisk Inand and SanDisk/Msys patents (corner the expanding embedded format) 5) SanDisk is putting a lot of effort to expand the use of MicroSD cards as a content distribution.

    I believe that $60-80M as royalties for all SD formats is reasonable estimate for 2008. It can be so much more in the future.

    For Samsung, as you know the royalties are reported one quarter in arrear and the Q4-07 Samsung NAND revenue were double the Q4-08 revenue. Samsung Nand revenue after adjusment ~$5400M for Y2008 , 335/5400= 6.2%. I believe that the new effective rate of Samsung is around 3.5%.

    For X4, I agree that there is a secretive agreement between SanDisk and Toshiba, which is not part of the 3D agreement. The last FAB restructuring agreement details all the prior agreement (cross license, JV, 3D) plus another one which is referred to as *.

    SSD, X4 controllers all represent upside too.

    I believe that in 5 years, SanDisk can have a stream of $1B from royalties (100% margin) or controllers (60-70% margin).

    • savolainen says:

      Hey Dan,

      Thanks for the link and your thoughts on the numbers.

      I agree with you that the upside potential for SD royalties (and sales) is overlooked.

      I was really surprised that Apple is now including SD slots on two of its MacBook Pro laptops. These notebooks dropped ExpressCard in favor of SD.

      I think this could be a significant move and a sign of far more to come.

      As you are no doubt aware, Apple is probably working on both a netbook and media tablet for release sometime in the next 12 months. Neither product is suitable for a DVD player. I am expecting both will depend on SD for removable storage.

      In addition Apple has some issues with Blu-ray. I wouldn’t be at all surprised if Apple is looking at SD as a workaround and a jump ahead.

      There are lots of angles which hopefully I’ll get to this next Sunday.

      Thanks again,
      Savo

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