SanDisk / Samsung Deal: Less Is More

Investment house Goldman Sachs recommends buying shares in chip companies ADI, Marvell Technology Group (Nasdaq:MRVL), and SanDisk Corporation (Nasdaq: SNDK). SanDisk was raised to a "Buy" with a target price of $22 on Thursday, a day after announcing a new royalties agreement with Samsung.

Despite the new contract, and a recovery in demand for flash memory chips, analysts remain at polar extremes about SanDisk. Bank of America analysts, for example, kept their "Sell" rating, with only a $7 target price, because they believe that the agreement for half the previous royalties percentages is bad for SanDisk, because the deal covers two new technologies, x3 and x4, and they also expect a 25% fall in flash prices by the end of September.

The fact that the deal was signed in May, not at the last minute in August, as many analysts expected due to the tough stances of the Koreans, may hint at the fact that it was SanDisk chairman and CEO Dr. Eli Harari who gave in, by agreeing to sign for half the royalties.

Harari is a long distance runner, and explained his strategy over the course of two conversations on the day of the announcement at a shareholder meeting and at a special analysts conference call.

Harari explained that in 2002, when the original deal was signed, SanDisk's MLC (x2) technology, which today rules the market, was then only at its early stages. Specifically with Samsung, it was only in 2005 that they succeeded to produce and sell at significant quantities. Therefore, only in recent years, when MLC sales skyrocketed to billions of dollars, they got to royalty levels that they didn’t even dream about in 2002 around $300 million per year - for SanDisk.

Harari feels it will be this way with the new deal as well in dollar terms, the royalties will reach new records in 2-3 years and last through the end of the deal in 2016, despite the fact that the royalties percentage is half that of the old deal.

Not only does he feel that the new technology will rule the market in 2-3 years, but there will also be "monster" markets by then in terms of size of flash memory usage specifically, smartphones and solid state hard drives (SSD) in computers and video game consoles, such as Sony's (SNE). Sony's new game console will come with a 16 gigabyte hard disk drive in addition to a slot for memory cards.

It need to be made clear that when x4 technology, which was developed by Dov Moran and his team at msystems, will go commercial, in the next 1-2 years, not only will SanDisk collect royalties on the flash chips themselves, but it will also sell the special controllers, without which the revolutionary technology can't operate, directly to Samsung, Toshiba, and others. Those controllers will be made by SanDisk itself or by subcontractors such as Tower Semiconductor Ltd. (Nasdaq: TSEM).

Harari also mentioned that something else that came out of the tense negotiations with Samsung was good personal chemistry with the new manager of Samsung's chip division.

Published originally by Globes [online], Israel business news - www.globes.co.il

© Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.