Monday, June 04, 2007

Sandisk (NASDAQ:SNDK): Color on ITC

- Deutsche Bank comments on Sandisk (NASDAQ:SNDK) after the ITC issued unfavorable initial determination in the SNDK-STM case, landing a major blow to SNDK's IP portfolio.

ITC's initial determination found that patent "517" was invalid & that STM's NOR did not infringe "338" (note: STM's NAND was already found not to infringe '338' back in Dec 2005). As a result, the firm believes that "338", based on which Samsung is currently paying royalty, no longer has any teeth. Moreover, the invalidity of '517' brings to question the depth and strength of SNDK's remaining patent portfolio.

As a result, the firm is quite confident that Samsung's royalty payments post-2009 will drop materially (likely close to or even below Hynix' ~$40m / year). This ruling is quite detrimental to SNDK's primary investment thesis (i.e. IP portfolio). If STM, a fledgling player in NAND flash, was able to manufacture parts in 2006 that were able to bypass most defensible SNDK patents at the time, surely Samsung by 2009 ought to be able to bypass all of them as well.

SNDK bulls will say that Samsung and Hynix are already paying royalty, so SNDK doesn't lose much with this ruling. However, DB points out that SNDK is trading at a premium to other memory peers due in large part to the value assigned to its IP portfolio.

No matter how they cut it, the firm does not see any reason to put new money into SNDK unless we see a material discount to their SoTP valuation (while today low-30s appears to be a good entry point, firm's view is likely to change with time). DB's base case SoTP valuation now drops to $36 from $39 (worst case is now $22 and best case $47). Maintains Hold.

- Someone forgot to tell Piper Jaffray about the ITC determination, because PJ is out on SNDK reiterating their Outperform rating and $51 tgt saying checks show continued strength in data-oriented phones, as well as increasing consumer interest in video and location-based applications that should drive solid growth in NAND flash demand.

For example, the firm noted solid sales of the LG VX8700 and Samsung u740 at Verizon, the Motorola V3xx at AT&T, the Samsung M620 "UpStage" at Sprint, and the Nokia 5300 at T-Mobile. In fact, the LG VX8700, which was the best-selling phone at Verizon according to checks, was highlighted by salespeople as offering support for up to a 4GB memory card, vs. a maximum 2GB for other phones. Firm believes this suggests carrier salespeople are increasingly highlighting the importance of NAND memory on mobile handsets.

Notablecalls: The License & Royalty side makes up over half of SNDK's operating income, meaning that without L&S the co may be facing losses after the current agreements expire. I'm sure the stock will get whacked today but considering there won't be any immediate impact from the ITC news and the fact NAND pricing has been surprisingly good (pointing to OK results), we may see a bounce. Low-30s is probably the best level to start from.

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