Merrill Lynch/BAM is out reinstating coverage on Sandisk (NASDAQ:SNDK) with an Underperform rating and $6 tgt.
Although its stock price has massively underperformed the S&P over the past three years, their PO of US$6.0 implies over 40% downside risk. They acknowledge its solid B/S (net cash) and IP (royalty revenue), but forecast large losses through 2009-10 and only a weak recovery in 2011.
Hit by excess JV capacity; needs to restructure biz model
SanDisk’s large exposure to NAND chip production capacity via its JVs with Toshiba is likely to remain a big burden, in Merrill's view. The JV’s transfer pricing for NAND chips (manufacturing cost plus mark up to generate breakeven performance or higher for the JVs) to SanDisk is far higher than spot prices (and vice versa in the case of chip shortage). This clearly indicates cost disadvantages during the downturn vs. pure OEMs. NAND industry model still indicates a glut even in 2010.
Large loss and off B/S items are negative catalysts
The firm expects negative EPS for three consecutive years (2008-10E). This is expected to lead to substantial book value erosion until 2010. Cost disadvantages (JV capacity) and potential downside risks to royalty revenue (license agreement with Samsung expires in August 2009) coupled with the NAND downturn also present risks to estimates and valuations. They also note that the lessors for the JV fabs may require earlier payments if SanDisk fails to meet its debt covenants.
New funding likely; dilution concerns linger
Merrill doesn't expect immediate cash drain, but SanDisk needs to preserve more cash for large operating losses and unexpected lease obligation payments for the JVs. They expect the company to raise about $500m from potential new equity financing in 2Q-3Q09 to meet estimates of their capex and working capital needs.
Notablecalls: Given the 10% run on Friday (and 30%+ run over last week), I think there's a trade in the short side in store. MLCO's comments will bring panic sellers.
I would not be be surprised to see SNDK retrace at least Friday's gains toward the $10 level (I may be too optimistic here as we may see lower levels.)
Although its stock price has massively underperformed the S&P over the past three years, their PO of US$6.0 implies over 40% downside risk. They acknowledge its solid B/S (net cash) and IP (royalty revenue), but forecast large losses through 2009-10 and only a weak recovery in 2011.
Hit by excess JV capacity; needs to restructure biz model
SanDisk’s large exposure to NAND chip production capacity via its JVs with Toshiba is likely to remain a big burden, in Merrill's view. The JV’s transfer pricing for NAND chips (manufacturing cost plus mark up to generate breakeven performance or higher for the JVs) to SanDisk is far higher than spot prices (and vice versa in the case of chip shortage). This clearly indicates cost disadvantages during the downturn vs. pure OEMs. NAND industry model still indicates a glut even in 2010.
Large loss and off B/S items are negative catalysts
The firm expects negative EPS for three consecutive years (2008-10E). This is expected to lead to substantial book value erosion until 2010. Cost disadvantages (JV capacity) and potential downside risks to royalty revenue (license agreement with Samsung expires in August 2009) coupled with the NAND downturn also present risks to estimates and valuations. They also note that the lessors for the JV fabs may require earlier payments if SanDisk fails to meet its debt covenants.
New funding likely; dilution concerns linger
Merrill doesn't expect immediate cash drain, but SanDisk needs to preserve more cash for large operating losses and unexpected lease obligation payments for the JVs. They expect the company to raise about $500m from potential new equity financing in 2Q-3Q09 to meet estimates of their capex and working capital needs.
Notablecalls: Given the 10% run on Friday (and 30%+ run over last week), I think there's a trade in the short side in store. MLCO's comments will bring panic sellers.
I would not be be surprised to see SNDK retrace at least Friday's gains toward the $10 level (I may be too optimistic here as we may see lower levels.)
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