A Billion Dollars

The last few weeks have been eventful. First Eli Harrari announced his retirement. Then SanDisk went out and borrowed a billion dollars. Without missing a beat, Mr Market gave SanDisk a 25%+ haircut.

I should add that Intel also went on a buying spree, picking up McAfee for $7.68 billion and the wireless processor business of Infineon for $1.4 billion.

So what does this all mean?

For starters, Intel isn’t going to be buying SanDisk anytime soon.

Intel

Before Intel’s recent shopping spree there was a compelling case to be made for why Intel would be interested in SanDisk. The key was Intel’s professed desire to be the technology and SSD leader.

As Intel seems to be dragging its feet in committing to its IM Flash Singapore fab with partner Micron, inquiring minds were wondering if the explanation might be SanDisk.

The answer appears to be no.

Personally I’ve never been convinced Intel would hang in there on either SSDs or NAND. NAND is a tough, tough business. Playing catch-up and with Micron as a partner looked to be a tall task.

To play in the high volume SSD market is going to take cutting edge, best-priced captive NAND supply. It’s also going to take technological expertise and IP.

Intel just dropped $9 billion + to acquire two companies that have nothing to do with either NAND or SSDs.

That says a lot.

Eli’s Retirement

I pretty much agree with Shlomi Cohen that, we probably won’t know until next year why Eli retired.

Shlomi has another very interesting take on the situation this week, where he makes the point that Samsung might be a likely candidate for a SanDisk buyout. Eli may have stepped aside, because such an eventuality would be tough for him.

I am gradually coming around to the idea that it’s entirely possible that Eli’s retirement is just what he says it is.

Eli says he’s going to take some time to smell the roses so-to-speak, while he’s still young-ish. Eli 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.

For a role model, Eli wouldn’t have to look any further than Irwin Federman, SanDisk’s last Chairman. Irwin had been a CEO and CFO of a couple of semi companies. He retired wealthy, became a venture capitalist, and appears to have generally had a most entertaining, productive, and profitable time hence.

Eli and Irwin go way back. When SanDisk was founded Irwin was the lead investor.

Good bet Irwin.

In 2008, when Samsung tried to buy SanDisk on the cheap, it was Irwin who wrote the thanks but no thanks letter.

All this said, if and when SanDisk is sold, my bet is that Toshiba will prevail at the end of the day. The price for anyone will likely hinge on the viability of 3D R/W.

A Billion Dollars of Convertible Notes

I have been somewhat puzzled about the timing of SanDisk’s decision to issue $1 billion  of convertible notes- now.

By my reckoning SanDisk doesn’t need the cash, even with fab 5 commitments.

2010 looks to be shaping up as a very good year. SanDisk is throwing off a lot of cash- probably $1 billion this year alone.

If SanDisk’s outlook is so great, why didn’t SanDisk simply wait until its stock price was higher?

SanDisk has said that the key rationale for the financing is to pre-fund its existing 2013 convertible maturity. The convertible market is strong and ostensibly SanDisk decided to take this opportunity to strengthen its balance sheet.

I am including Judy’s remarks from the 18 August conference call below. Her closing remarks:

“I’d like to end by summarizing the key rationale for today’s financing, which is to pre-fund our existing 2013 convertible maturity, in what we believe is a strong convertible market.

Raising this cash is expected to be neutral to accretive to EPS on an interest, income and income expense basis, and we are minimizing the potential long term dilution by entering into bond hedge and warrant transactions to raise the effective conversion premium to 75%.

And we are doing so at a very minimal after-tax cost to SanDisk.

We believe that it is prudent balance sheet and capital structure management offers us flexibility to fund our capacity expansion including flexibility in the amount of operating leases that we may utilize and allows us to pay off our existing convertible debt and have flexibility for other corporate purposes. All while maintaining a very strong balance sheet.”

I can’t help but wonder whether that throw away line “and have flexibility for other corporate purposes”, isn’t in play as well.

Acquisition?

One corporate purpose where cash – now-  would come in most handy would be for an acquisition. Maybe SanDisk will step up where Intel is reluctant to tread.

It’s not like SanDisk hasn’t been willing to play the acquisition game in the past. FLSH was acquired by SanDisk in 2006 for something like $1.5B. Matrix was acquired in 2005 for $238 million.

The three areas which should interest SanDisk: 3D R/W, X3 and SSDs.

I’m going skip over 3D R/W and X3 and go right to SSDs.

SanDisk has been hinting for a while now that they’re going to be a player in enterprise SSDs in the not so distant future.

If so, something needs to be done to fill the SSD gap between what SanDisk has now and where they want to go.

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

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

To my mind the focus would likely be MLC SSDs for the enterprise. An acquisition might do the trick or at a minimum provide a bridge.

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 from Irwin). A $1 billion convertible was announced and then an acquisition was announced (FLSH).

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

Four months to go, though.

**** Judy’s Remarks from the 18 August conference call below****

Judy Bruner:

Thank you Eli and good morning everyone.

As Eli just summarized, SanDisk is in a very strong financial position today.

Turning to slide 20, in terms of cost reduction we have executed exceptionally well with greater than 50% cost reduction in each of the last five years. Even including the impact in 2009 of capacity under-utilization.

This cost reduction comes from technology transitions, from our scale and from aggressive cost reduction in our back-end assembly and test.

As for 2010 we expect our cost reduction to be greater than 40%, which we believe is at the forefront of the industry.

Turning to slide 21, our gross profit margin rebounded rapidly in 2009 due to our restructuring actions, strong cost reduction and our volume growth and our total GMs has now been in the high 40% range for the last four quarters.

In addition we have also managed our expenses very carefully, which when combined with our gross margins have produced very strong operating margins in each of the last four quarters. In fact operating margins have been greater than 30% in the last three quarters.

Turning to slide 22, and looking at our P&L performance on an annual basis, the last twelve months have produced the strongest annual financial performance in the company’s history for revenue, gross profit, operating profit, and net income.

Turning to slide 23 in terms of capital investment we are investing at a moderate level in 2010 funding technology transitions in fab’s 3 and 4 and also capacity expansion within fab 4. Our investment level for 2010 is 22 to 23% of our estimated revenue. And this is nicely within the 20 to 30% range that we believe is the right range over the long term for our capital investments. A range that we believe allows us to balance growth and positive free cash flow.

We are very focused on disciplined capacity growth and capex investment and today’s offering does not signal any change in that approach.

I’d like to point out that our net cash outlays for capital investments has been substantially less than our actual capital investments because a significant portion of our investments have been funded by JV working capital and by very cost effective operating leases in the Japanese marketplace.

Turning to slide 24, like our P&L our cash generation has also shown strong improvement over the past 6 quarters. In fact for the first 6 months of 2010 our cash flow from operations at 713 million was more than we had previously generated in any full year. And the majority of those investments were funded by joint venture working capital resulting in very little cash used in investing.

Our free cash flow for the first half of 2010 was 691 million.

Turning to slide 25, our cash and marketable securities increased by $700 million in the first half of 2010 to over 3.7 billion and our net cash increased by 776 million, nearly 2.6 billion.

We have also substantially reduced our off-balance sheet equipment lease guarantees which are now below 1 billion compared to 2.1 billion at the end of 2008.

Turning to slide 26, in summary, we have emerged from the 2008 downturn stronger than ever based in large part on the decisive and proactive actions we took in late 2008 and early 2009.

I’d like to end by summarizing the key rationale for today’s financing, which is to pre-fund our existing 2013 convertible maturity, in what we believe is a strong convertible market.

Raising this cash is expected to be neutral to accretive to EPS on an interest, income and income expense basis, and we are minimizing the potential long term dilution by entering into bond hedge and warrant transactions to raise the effective conversion premium to 75%.

And we are doing so at a very minimal after-tax cost to SanDisk.

We believe that it is prudent balance sheet and capital structure management offers us flexibility to fund our capacity expansion including flexibility in the amount of operating leases that we may utilize and allows us to pay off our existing convertible debt and have flexibility for other corporate purposes. All while maintaining a very strong balance sheet.

Now we will open your call to questions.

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6 Responses to A Billion Dollars

  1. Poofypuppy says:

    Thanks, Savo. As always, your post is highly informative and reassuring, although the stock price action for SNDK over the last few weeks has been anything but. Despite the seemingly strong fundamentals and future outlook, it makes one wonder who are the fools, the ones who [continue to] hold SanDisk, or the ones who have been selling.

    Regards
    Poofy

    • savolainen says:

      Hey Poofy,

      Hope you had a good summer.

      I’m about to head off on a hiking trip among the grizzlies in Glacier National Park. We’ve read our bear attack books, and will be picking up pepper spray in Kalispell.

      Wish us luck.

      The section I didn’t get to in this last post was speculation regarding SanDisk’s recent price action. I admit I got a bit distracted by Irwin Federman- a guy I’d never paid any attention to.

      I find it curious and encouraging to “stumble” on these very smart folks on the SanDisk inner circle. I have no doubt that Irwin has left a significant imprint on SanDisk. If you had asked me a couple of weeks ago, I would have guessed – incorrectly- that Eli had been chairman all along.

      Eli took over from Irwin in 2006.

      This is only significant if one is wondering about the significance of Eli’s recently stepping down as chairman and CEO. I could be entirely wrong speculating about Irwin as a role model for Eli.

      On the other hand maybe not. These guys have known each other for decades. Irwin is almost ten years older than Eli. I am guessing that Eli sees a bit of himself in Irwin.

      As Shlomi said, we should know next year.

      Personally, I can imagine Eli stepping back from the day-to-day operations/headaches, and happily leaning into the role of visionary.

      On a side note I’ve been wondering about a few job openings at SanDisk.

      Sanjay has stepped up as CEO.

      It would make sense for Yoram to be promoted to Sanjay’s job as President and COO and then for Dan Inbar and/or Daniel Schreiber to take over/split Yoram’s responsibilities as VP OEM & Corporate Engineering.

      So far nada.

      It could be that the announcements will be made in due time.

      Another possibility is that there are other folks who might step up. Or be introduced as outside hires or new faces from an acquisition (?).

      I’m stuck on the SSD angle because I think it’s going to be the 2011 story. Hopefully SanDisk will have something for show and tell.

      ****

      FWIW, my take on the price action is that it is business as usual in SanDisk land. My guess is that SanDisk has such a high beta because deep-pocketed folks have figured out how to profit from and precipitate swings such as these.

      I am guessing this swing had some snap, because stars aligned.

      SanDisk has had a great run this year. I wouldn’t be at all surprised if some big shareholders, such as FMR, wanted to lock in their profits. If they’re going to be selling large numbers of shares, I would think they would bet accordingly.

      This coupled with the bond offering arbitrage probably made for a compelling short for a number of players and their friends.

      My guess is that these folks have now made theirs and are sitting back counting their money and watching for the next opportunity on either side of the bet.

      Where we go next will likely depend on earnings, and supply/demand in the context of the greater semi market/economy.

      FWIW, 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.

      Regards,
      Savo

  2. Poofypuppy says:

    Savo, have a fun/safe trip to the national park. And yes, have your bear contingency plans and ‘play dead’ routines ready.

  3. Dahotruth says:

    Savo
    Long time reader first time poster.Thanks for your insight and thoughtful analysis. While Eli’s retirement and Sanjay’s succession was predictable and signaled to the market, seems the choice of doing it in conjunction with an ER release was not well thought out, that said, they seem to have improved their all around “communications” with the marketplace from past days. Perhaps Eli does want to just “go fishing” but I suspect there was more than one reason. Not a question “if” SNDK will be bought just “when” IMHO. Does your thoughts of potential acquisition targets include SIMO? Does not seem like a that would be a “big bite” and the IP could prove valuable over longer term.Thoughts?

  4. Raj says:

    Savo,
    I have been reading you blog for long time. Thank you for insightful posts. Do you have any comment on the recent downgrades from Auriga and Stern Agee.
    Regards,
    Raj

  5. Richard Tauber says:

    Savo,

    Thanks for all your insightful comments.

    You mentioned that Sandisk might be interested in a enterprise SSD company. What do you think of STEC as an acquisition?

    Thanks,

    Richard

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