Supply Constrained

There are worse problems to have.

According to the Q2 conference call, SanDisk can sell every chip it can make and then some. And for tidy profits.

Demand is outstripping supply. But supply is limited. SanDisk is supply constrained.

Exactly what this means and in what time frame isn’t as obvious as it might seem at first take. Supply constrained means growth limited by supply. In this case the limiting supply factor itself is growing.

How much or how fast SanDisk’s supply is growing, is what this post is about.

Wafers vs Bits

There is a big difference between wafers and bits.

Projected growth rates for each are very different. Wafer supply growth for SanDisk is ho-hum over the near term. Bit supply adds the juice.

For 2010, wafer production for SanDisk will likely grow only around 10%. In other words, not much.

On the other hand, bit growth should be 70% to 80%. Big difference. Especially since revenues are driven by bits.

Wafer Growth

The graphic below illustrates Merrill Lynch’s estimate of SanDisk- NAND JV fab capacity  from 2009 through 2012 in thousands (K) of Wafers per Month (WPM). The WPM’s shown are the combined share of Toshiba and SanDisk.

As shown Fab 3 was maxed out already in Q1 2009. It was running and continues to run at 150 K WPM. So far so good for ML, though that’s about it.

ML seems to have completely blown it for Fab 4. Q1 2009 through Q2 2010 is shown as 110 to 113 K WPM. During this time, Fab 4 has been running at closer to 160 K WPM which when combined with Fab 3’s 150 K WPM gives a total JV capacity of 310 K WPM.

By the middle of 2011 Fab 4 will be maxed out at 210 K WPM giving a total JV capacity of 360 K WPM.

As far as SNDK’s share of the today’s JV total capacity: after the restructuring in early 2009, the split between SNDK and Toshiba is about 40/60. SanDisk’s share has been about 125 K WPM and Toshiba’s 185 K WPM.

We know SanDisk’s share because at Investor Day 2010 (slide 61) SanDisk said that in 2009 its yearly wafer output was 1.5 million 300mm wafers. 1.5m/12= 125 K.

Today SanDisk and Toshiba are fitting out the last of the remaining space in Fab 4 and are going to split that capacity of 50 WPM 50/50. SanDisk and Toshiba expect to reach full capacity of Fab 4 by the start of production in Fab 5- which means Q3-ish 2011. About 1/2 of this additional shared production should be available by the end of 2010- SanDisk and Toshiba should each pick up another 12.5 WPM.

So by the end of 2010 SanDisk will have 137.5 WPM (+10% for the year) and by Q3 2011 should be up to 150 WPM.

And then Fab 5 kicks in.

SanDisk has said that in 2011, Fab 5 will account for no more than 10% 2011 wafer (production). SanDisk also has said that Fab 5 will only contribute single digits in terms of percentage of its overall supply in the second half.

I’m going to guesstimate this means another 15 K WPM by the end of 2011, bringing SanDisk’s total up to 165 K WPM.

If this is how it works out, by the end of 2011, SanDisk could have 20%± more wafers than at the end of 2010 or 32%± more than today.

SanDisk’s Lost Wafer Capacity

In early 2009 SanDisk restructured its flash manufacturing joint ventures with Toshiba. As part of the agreement, more than 20 percent of the joint ventures’ capacity was transferred to Toshiba. The total value to SanDisk was approximately $890 million.

This 20% of capacity translated to about 30 K WPM which SanDisk lost.

I suppose, if Toshiba were agreeable, SanDisk could buy back this capacity. I think this unlikely though, because first, no one has been talking about this possibility, and second, Toshiba reportedly already has its customers on allocation.

One Toshiba customer in particular would probably have to be squeezed, and Apple isn’t likely to be too happy about that.

Bit Growth

NAND chips are produced from wafers. These days the standard wafer is 300mm in diameter. As the graphic below illustrates, lots of chips (the little squares in the grid) are produced from each wafer.

How many chips will fit in that 300mm circle depends on how small the grid. The smaller the better- if bits per square (or chip) are equal.

Both process node and the number of bits per cell are key for chip size. The smaller the node, and the more bits/cell- the smaller the chip can be. And, the more chips/bits can be produced from each wafer.

For example SNDK’s X3 32 Gb 32nm die size- 113 mm2. Intel’s 34nm 32 Gb MLC X2- 172 mm2.

Another example- SNDK’s 32nm, 32Gb X2 is 140 mm2  in size. SNDK’s 32nm 32Gb X3  is 113 mm2.  X3 provides ~20% more Gigabytes/wafer which translates directly to 20% more profit where X3 can do the job of X2. And hence the importance of X3.

Yields too, come into play. The more chips are good per wafer, the bigger the bit supply.

In the recent Q2 conference call, SanDisk noted that its captive bit supply is growing at approximately 75% for 2010. 2011 looks like more of the same: “75 to 80% bit growth for 2011 over 2010.”

Given that wafer growth in 2011 looks to be double that of 2010 and 24 nanometer will in full ramp in 2011, I suspect that 80% bit growth will prove low.

Other Silicon Sources

As far as I know, no specifics have ever been released on the details of SanDisk’s non-captive supply agreements with Samsung and Hynix. It has been announced that both are legally obligated to set aside supply for SanDisk under certain conditions.

Right now SanDisk isn’t using any of this potential non-captive supply, but that’s about to change.

In the Q2 conference call, SanDisk revealed that it has placed orders for non-captive supply for both Q3 and Q4. Sanjay Mehrotra:

“Daniel, as you know, our demand has grown rapidly during the course of the year. In fact, we have raised the revenue estimate second time giving – compared to the start of the year now. So we are basically running as fast as we can in terms of really fulfilling the demand, and that includes maximizing our captive supply, but, yes, also tapping into the NAND non-captive sources. So we saw the demand increasing during the second quarter. We placed orders for the non-captive supply. We’ll be receiving it in third quarter. So in terms of shipments, the impact of non-captive in third quarter will be small, and in the fourth quarter, it will be somewhat larger. But as Judy said, overall, for the second half, still, it will be in single digit percentage.

So there are several factors that we look at in managing our non-captive business. We want to make sure that we are managing it prudently. And some of the considerations include margins, the mix of the product as well as basically the timing of the supply that’s available. So looking at all of that, our picture ahead is single digit percentage in the second half of non-captive utilization.”

From SanDisk SEC filings:

“The Company’s contracts with its other sources of silicon wafers generally require the Company to provide purchase order commitments based on nine month rolling forecasts.  The purchase orders placed under these arrangements relating to the first three months of the nine month forecast are generally binding and cannot be canceled”

Non-captive doesn’t work for OEM or specialized/optimized uses like SSDs.

To my mind non-captive supply has the potential to be a Q4 buffer, and maybe suitable for picking up a few bucks. Hopefully SanDisk can profit from its non-captive supply agreements in these tight times.

I had hoped to get to free cash flow, Intel and the implications of Eli’s departure, but time’s running out so I’m going to call it a day here.

Personally, I’m not worried about SanDisk’s supply. Heck, captive bit growth looks like its going to be north of 75% through the end of 2011 with guaranteed additional non-captive supply waiting in the wings.

If current demand keeps pace, SanDisk should bank a pretty penny.

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12 Responses to Supply Constrained

  1. Chingadera says:

    Savo, Another masterful piece. I think we will have plenty of new subject matter soon. Thank you for your informative post. Chinga

  2. Bill says:

    Savo,

    Any thoughts on the recent decline in SNDK? Who’s right? Bank of America/ML (As Bank of America/Merrill Lynch analyst Simon Dong-je Woo notes in a research report, TLC NAND pricing is down about 20% already in the current quarter. And he also reports that SanDisk has more exposure to TLC NAND than other players in the sector, accounting for 65% of the company’s overall NAND chip sales. )or Sterne Agee (Sterne Agee notes SNDK stock has pulled in significantly with concerns about retail slowdown and TLC pricing. But firm believes overall NAND trends continue to be healthy with SNDK customers pointing to solid 3Q revenue growth. Its checks with NAND Flash Card OEMs in Taiwan indicate C3Q(Sep) revenues tracking up 10-15% q/q vs SNDK guide of flat q/q. Firm believes July monthly revs for the NAND card OEMs, which are getting about 25-30% supply from SNDK, were up 15%+ q/q with about 5 weekends in July. August is tracking flat q/q, but September should pick up again.) I think the guy from BofA is moronic; however, I am the moron for holding on the stock, while he looks smart. How about some thoughts about stock prices for a change. Thanks in advance.

    • savolainen says:

      Hey Bill,

      Have been traveling and otherwise occupied. I hope to get a post up this weekend before taking off for a hiking vacation among the grizzlies (Glacier NP), but we shall see.

      As far as who’s right between Bank of America/ML and Sterne Agee, my guess is both.

      The last I saw Bank of America/ML had SNDK as a buy with a $60 target.

      Sterne Agee also has a buy on SNDK.

      As far as TLC NAND pricing goes, it is down, but what this means for SNDK isn’t clear, at least to me. Yes SNDK is the biggest TLC player, but they are also the most accomplished in leveraging TLC into performing up to MLC specs.

      I expect Judy to address TLC pricing and 2H guidance at Citi on September 8. My guess is that she will repeat comments from the Q2 cc: not all TLC is created equal and 2H is on track. We shall see. The proof of this pudding will be Q3 results.

      As far as why the recent sell off? You probably have a much better sense of all the angles on bond arbitrage than I. My guess is that the angles are being played and that for the significant players this opportunity is being leveraged.

      Tech’s are down as is the market overall. Semi’s seem specially selected for punishment.

      And then NAND pricing is “down”. Again this is a relative world. The overarching question is whether pricing is down more than cost reductions. I am inclined to think that the big NAND players including SNDK have their bases covered and that price declines will not exceed cost reductions.

      All this said, I suspect that there is more news to come from SNDK. Rumors have had SNDK as acquisition target. I am inclined to think it more likely that SNDK is looking to acquire.

      There is enough cash around now.

      It has been a while since SNDK was in acquisition mode. FLSH was acquired in 2006 for something like $1.5B. Matrix was acquired in 2005 for $238 million.

      The three areas which come to mind: X3, SSDs, and 3D R/W.

      Technology/IP would be key. And complementary technology. Both offensive and defensive (slowing down the competition).

      I am wondering about enterprise MLC SSDs. SanDisk has been making noises about entering the enterprise market for a while now, but hasn’t released any product which seems suitable. An acquisition might do the trick or at a minimum provide a bridge.

      Given the Israeli SNDK/FLSH roots, am inclined to think that prime acquisition candidates might be Israeli- maybe private.

      That said, I’ve run these ideas by trusted informed Israeli friends who don’t agree with my logic.

      Regards,
      Savo

  3. Dave says:

    Savo,
    I’m still trying to understand Eli’s retirement, and I’m hoping you can help me. If Sandisk was to sell this year verses selling next year, after Eli retires, what potential advantages are there selling Sandisk to Eli after he has stepped down? Thanks in advance. I respect your inputs, and find them helpful.

    • savolainen says:

      Hey Dave,

      You’re not alone in trying to understand Eli’s retirement. Lots of us are wondering what’s up.

      I pretty much agree with Shlomi Cohen that (if anything is going on) we probably won’t know until next year:

      “In my opinion, maybe only in another year will we understand why Harari decided suddenly, at the peak of his career, in the summer of 2010, to be a good grandfather to his grandchildren”

      http://www.globes.co.il/serveen/globes/docview.asp?did=1000582472&fid=4111

      Shlomi has another very interesting take on the situation this week, where he makes the point that Samsung might be the most likely candidate for a buyout:

      http://www.globes.co.il/serveen/globes/docview.asp?did=1000585500

      If SanDisk is sold, my bet is that Toshiba will prevail at the end of the day.

      If SanDisk is being primped up for a sale soon, my guess is that it’s because 3D R/W doesn’t look viable commercially. If this is the case, better for SNDK to cash out before it becomes clear that another post-NAND technology will prevail.

      If 3D R/W SNDK-style is looking like a winner to those in the know, why sell now before the word is out? Much better to exercise some patience, get the news out, and then cash out.

      How high that might be is anyone’s guess- but its triple digits.

      Eli has it made financially for this lifetime- regardless of the scenario.

      I think it entirely possible that Eli’s retirement is just what he says it is: He’s going to take some time to smell the roses so-to-speak, while he’s still young-ish. He says SanDisk is in great shape through 2011 and therefore this is a good time to retire.

      If I were in his shoes, it’s what I’d do.

      Best,
      Savo

  4. joncon63 says:

    I wish Eli the best. Truly. As a shareholder, I very much appreciate his years of hard work. I hope he enjoys many years of retirement.

    I am struggling to understand the bond offering. It is at worse terms than the last offering. So why rush to do it now? All signs up to the bond offering pointed to SNDK selling itself, starting with the hiring of Sumit Sadana. Then there was the phrasing in the Fab5 deal with Toshiba that seemed to indicate SNDK was in talks with a handful of interested suitors. Then eli’s retirement, and appointment of Michael Marks — a dealmaker and not a SNDK insider — as chairman.

    the bond offering seems to throw a roadblock in that path

    • Sam says:

      Actually, I don’t think that the bond offering throws a roadblock at all. If they buy back the older bonds, and the company gets bought for, say, $65, the new bondholders will make money while the old bondholders wouldn’t have (due to the higher strike price).

      That said, Savo’s thoughts on a possible acquisition makes sense as well. Buying a company like FusionIO (I’m just giving an example here, definitely not making a prediction) would probably help both companies. The SSD sweepstakes are going to be rough, although I don’t think that they will be as rough as the HD sweepstakes were back in the 80s, early 90s, mainly because so few companies have direct access to flash chips, and those companies should be the ones with the inside track in the market.

      As I’ve written here and elsewhere before, I really really wish Al Shugart was still around. His presence, experience and counsel would have been invaluable for the coming SSD Battle. Well, enough of that!

  5. MorganBucks says:

    The bonds basically pay off bonds coming due without using cash or increasing or (decreasing) debt.

  6. JohnG says:

    Hello,

    Just a little note,
    I went to the Flash summit in Santa Clara mid-august.
    2 things I noticed during Eli’s presentation that are not visible on the powerpoint file.

    First, He said that Sandisk will be strong in the Enterprise SSD soon. So it means something needs to be done to fill the gap between where they are and where they want to be, and pushing up NAND production might not be the only answer.

    Then, after the standing ovation at the end of his speech, Eli thanked the crowd and said that he will continue to meet the people he’s been working with for 20+ years and he will continue to be around. It didn’t sound at all like someone who is going to limit his activities to a consulting job for Sandisk only, or someone who is going to retire on his Yacht for the rest of his life…

    Just 2 thoughts for the summit.

    • savolainen says:

      Hey JohnG,

      Thanks for the comments. They fit.

      The Flash Summit must have been interesting. I’m inclined to agree with Eli that flash is going to bigger than folks think.

      Enterprise SSDs are very interesting. SanDisk has been hinting for a while now that they might be a player in the not so distant future.

      I agree that something needs to be done to fill the SSD gap between what SanDisk has now and what they need to be “strong” in enterprise SSDs “soon.”

      Two possibilities come to mind: an in-house project we haven’t heard of or, an acquisition.

      As mentioned, if there is an acquisition in the works, technology/IP will be key. And complementary technology. Both offensive and defensive (slowing down the competition).

      The focus will likely be MLC SSDs. Doubt SNDK is going to try the SLC route.

      Recently I went back into SNDK’s 2006 press releases to look for the last bond offering.

      I was struck by a remarkable similarity to 2010: A new fab (fab 4) was announced. A transition was announced at chairman (Eli took over). $1 billion convertible was announced and then and acquisition was announced (FLSH).

      So far in 2010 we have 3 out of 4. The only one missing is an acquisition. 4 months to go though.

      Regards,
      Savo

      • Chingadera says:

        Hello everyone, I have also been scratching my head. It has crossed my mind that Eli may be working on a management led LBO. I will add more thoughts soon. In the meantime, I would like to hear everyone’s thoughts. Thank you and good evening.

  7. Geoff says:

    Thanks for all these comments.

    Can someone post, direct me to websites, or forward me relevant notes or transcipts from the Flash Summit.

    Kind regards.

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