Wednesday, January 31, 2007

Color on quarter: Sandisk (NASDAQ:SNDK)

Several comments on Sandisk (NASDAQ:SNDK) after the co issued strong Q4 results but dismal guidance:

- Merrill Lynch notes SanDisk delivered a solid quarter, but management's outlook was as shaky as the firm can remember. Industry oversupply in the first half of the year has limited any visibility into pricing for the year. ML has lowered their 2007E adjusted EPS estimate from $2.50 to $1.80, and our GAAP estimate from $2.10 to $0.88. Given that NAND prices still have room to fall, they see no need to upgrade SanDisk yet. As is so often the case, the stock will probably over react to intermediate-term problems despite the merits of owning it longer term. On the much lower numbers, valuation is not that compelling either. Firm's rating stands at neutral.

The pricing implosion at SanDisk has negative implications for the intermediate term, but enormously positive implications for the longer term. The firm notes they wrote late last year that they expected NAND flash to be at $1 per gigabit by the end of 2007, at which point solid-state drives (SSD) for mobile computers might start to become a reality. They are below $1 a gigabit already, and they think price could be down to $0.50 a gigabit by the end of the 2007. At that point, the prospect of $200 50GB storage devices ($0.50 x 8 x 50) becomes quite interesting.

- Citigroup says that against the backdrop of weak semiconductor company 4Q06 results, SanDisk's top and bottom line strength, albeit with blemishes, surprised favorably. However, and more importantly for the shares, a slew of unexpected outlook negatives, with few offsetting positives: 1) produced dramatically lower 1Q07 revenue and EPS, 2) decreased conviction in a mid-2007 product gross margin rebound, 3) added fresh concerns about the merits of the mSystems acquisition (just closed in late-November) and 4) cast doubt on the marketing muscle behind SanDisk's own MP3 and USB retail product execution ahead of new product launches in 2Q07. Further, SNDK's own aggressive production ramp through 2007 (F3 Dec, 2006 WPM of 70k exceeded Citi's 50k estimate; capacity now targeted at 136k WPM vs. 110 previously), adds to concern about excess industry production. Overall, their new 2007 and 2008 revenues each decline by 12% while EPS estimates decline 45% and 26% respectively. Similar declines to Street estimates are likely with little compelling evidence to assert confidently that a firm bottom has been set in firm's forward estimates.

They remain cautious on SNDK shares, seeing little reason to get more aggressive near-term in what is typically a (still distant) second-half play (albeit with powerful though well-known secular catalysts). A trough EPS multiple of ~16x on our 2008E estimates implies a valuation range of $35. Next week's MU analyst day seems likely to contribute to near-term share volatility, as sector supply growth concerns rekindle and as Lexar retail market share recapture concerns begin to brew. Thus, SanDisk's own February 26th analyst day may be the next potential catalyst in refurbishing now-tarnished investor confidence. Time, or the shares falling to below $35, could potentially cause the firm to reconsider their Holdrating and potentially increase interest in the shares. Target goes to $46 from $52.

- Deutsche Bank maintains their cautious stance on SNDK as they believe it will continue
to prove a prudent position. Highlighting the currently treacherous NAND flash environment, SNDK declined to give any guidance on full-year ASPs, GMs, or License & Royalty stream. Given this lack of visibility it is hard to see significant buyers stepping up to the plate (unless enticed by hopes of a technical rebound). Firm lowers theirtarget price to new SoTP value of $38 and remains on the sideline until they see a material discount to this fair value (given high beta).

SNDK moving away from giving bit growth and ASP guidance: They view this as negative as it significantly reduces Investors'/Analysts' ability to wrap their arms around the story. This is after all a memory company - bit growth and ASPs are key factors in modeling the business.

$300m stock buy-back approved: Given the high level of dilution through stock option grants, they believe this is a step in the right direction by the company's board. However, the buy-back is not large enough to signal that the board believes stock to be significantly under-valued.

- Goldman Sachs says they had hoped that the company would commit to scaling back its capacity additions, which would have allowed for NAND supply/demand dynamics to improve in 2H2007/2008. However, management appears committed to adding capacity, despite a continued very weak pricing environment. While they expect the stock to find a near-term trading floor in the upper $30/$40-range, they do not see any catalysts to drive the shares higher in the near-term in light of the company's unwillingness to scale back on capacity additions. The firm therefore recommends that only the most aggressive investors buy the stock today. That said, they continue to recommend a long SanDisk/short SPE pair trade, as they believe SanDisk is pricing in weak NAND fundamentals while the SPE stocks are not.

Notablecalls: I think SNDK is headed lower in the intermediate (1-3 month) term. How much would you pay for $1.80-$2.00 EPS power in 2007? 20x? Probably less, something more closer to 16x. Luckily for the holders of common, SNDK's price to book still stands strong. I have no view on what the stock will do in the very s-t. Suspect there will be a bounce. But that's a low conviction call.

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