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Shareholders in SanDisk Corporation (SNDK) have seen very healthy returns so far in 2013. Last week, SanDisk announced the strategic acquisition of SMART Storage Systems, in an attempt to fortify its position in the enterprise market. After the strong share price performance so far in 2013, shares offer little appeal at the moment, despite the modest valuation and the expected operational improvements for the year. The recent strong momentum in average selling prices is inflating the current prospects,in my opinion.

The Deal

SanDisk announced that it has entered into a definitive agreement to acquire SMART Storage Systems. The company will pay $307 million in cash and equity-based incentive awards for the developer of enterprise solid state drives (SSDs).

The leader in flash memory storage solutions will buy the company from investment funds tied to Silver Lake. The 250 employees of SMART will join SanDisk following completion of the deal. SMART's SATA and SAS enterprise SSD offerings, including its Guardian Technology solutions, extend the endurance of NAND flash memory while improving reliability.

Chief Strategy Officer Sumit Sadana commented on the rationale behind the transaction, "SanDisk is excited to build upon its leadership position with its fourth acquisition in the enterprise storage market. This acquisition enables SanDisk to address a $1.6 billion market opportunity in SATA products, and complements our strong enterprise SAS product portfolio."

SMART Storage Systems generated revenues of $25 million over its past quarter which ended in May, 2013. While the company is rapidly growing, the transaction will be slightly dilutive to SanDisk's non-GAAP earnings per share in the second half of 2013. Shareholders should expect some accretion to occur to 2014's earnings.

A simple extrapolation of the revenues being generated over the past quarter shows that SMART Storage Systems could surpass the $100 million revenue mark for the full year. This values the company at roughly 3 times annual revenues. The deal has already been approved by the board of directors of both companies and is expected to close as early as August of this year.

Valuation

SanDisk ended its first quarter of 2013 with $3.31 billion in cash, equivalents and short-term investments. The company furthermore holds $2.88 billion in long-term marketable securities. SanDisk holds $1.72 billion in convertible debt, for a solid net cash position of around $4.5 billion.

Last year, SanDisk generated annual revenues of $5.05 billion, down 10.8% on the year before. Net income more than halved to $417.4 million. The company did manage to grow first quarter revenues for 2013, which rose by 11.2% to $1.34 billion. Trading around $60 per share, the market values SanDisk at $14.7 billion. Excluding the solid net cash position of the firm, operating assets are valued just above the $10 billion mark. This values the company at roughly 2 times annual revenues and 24-25 times last year's earnings. Despite the solid cash position, SanDisk does not pay a dividend at the moment.

Some Historical Perspective

Despite the struggles over the past year, shares of SanDisk trade at multi-year highs. Shares rose from merely $20 in 2004 to peak in their seventies by the start of 2006. Shares fell hard during the financial crisis, to lows of $5 in 2008. Shares gradually recovered to levels around $60 at the moment.

Shares have already risen by almost 40% so far in 2013. This move is on the back of the operational improvements in recent quarters, driven by a recovery in average selling prices. First quarter average selling prices fell 18% on the year, but were actually up 2% on the quarter before. This marked the first time in the company's history that average selling prices have risen two quarters in a row.

Between 2009 and 2012, SanDisk managed to increase its annual revenues by more than 40% to $5.05 billion, despite a weaker full year of 2012. Net income stagnated around the $417 million mark.

Investment Thesis

It is not just SanDisk which is looking for bargains in the SSD field. Back in June, Western Digital (WDC) announced the acquisition of troubled STEC (STEC). Similar to the deal which Western Digital made, the acquisition of SMART is just a drop in the bucket for SanDisk, adding merely 2% in annual revenues. The price tag, at roughly 3 times annual revenues, represents a significant premium compared to SanDisk's own valuation at 2 times annual revenues, based on the valuation of its operating assets. Yet the deal is of a highly strategic nature in an attempt to improve its product offerings across the entire company, in which the technology of SMART can be crucial.

The deal will furthermore aid SanDisk to reduce its reliance on consumer sales, shifting towards the enterprise market. While the strong growth in smartphones will continue to drive growth in the medium-term future, long-term threats are emerging on the back of cloud offerings which make local storage memory less relevant. A whole range of apps based on cloud-based offerings allow smartphone users to make more pictures, movies and store more music without necessarily increasing the memory of their mobile device.

For now, SanDisk is on track to generate annual revenues of $5.60-$5.75 billion for the full year of 2013, marking another record year. As earnings could approach the $1 billion mark, operating assets are valued around 1.8 times annual revenues and 10 times earnings.

Despite the record results, the strong cash balances, and the modest valuation, I remain on the sidelines. The strong momentum, driven by recent strength in average selling prices, have propelled shares higher this year. This leaves little room to the upside in the immediate term, in my opinion.

Source: SanDisk: Little Short-Term Appeal Despite Smart Acquisition Of SMART