SanDisk Will Get Last Laugh Against Analyst Models

Includes: FLSH, WDC
by: Shlomi Cohen

Despite beating the analysts’ estimates for sales and profit line, SanDisk Corporation (Nasdaq: SNDK) saw one fifth of its value, or $2.4 billion wiped off its value last Friday. So what caused this massacre? Apparently, on Wall Street, beating the forecasts isn’t enough; you have to achieve this in a manner that most closely resembles the models that the analysts calculated. SanDisk, on the other hand, did it in its own way.

It turns out that the company president and CEO Dr. Eli Harari managed to beat the market’s third quarter forecast using his own flexible business model, since, as is commonly known, not only does he sell flash memory cards for a wide range of gadgets, but he is also a mega producer of chips. The right combination of these two is a task in itself, since its main goal is to hit targets while in motion throughout the quarter.

Generally speaking, Harari did what he has done countless times in the past. It always works out to his satisfaction but it also makes considerable waves on Wall Street and, in the past, as an investor in M-Systems Flash Disk Pioneers (Nasdaq: FLSH), I complained about these waves since they always sent flash stocks down despite the fact that they later rose again to new highs.

In short, Harari lowered prices of products for the end consumer during the third quarter, thereby substantially boosting demand for his products. But despite the reduction, he managed to reach and even beat the quarterly sales targets that the market set him, since demand for these products is extremely flexible.

On the other hand, Harari recouped the profit he lost by lowering prices from “in-house sources,” meaning from profit reserves created during the quarter as a result of extremely high efficiency in the MLC NAND chip production activity at factories jointly owned by SanDisk and Toshiba in Japan. An additional source of profit came from Samsung Electronics, which paid SanDisk additional royalties because it produced and sold NAND chips in greater numbers, mainly to Apple Computer Inc. (Nasdaq: AAPL).

Expressing their disquiet at SanDisk’s results, the analysts said that beating the earnings per share estimates was fine, but in doing so Harari had harmed gross profit margins which fell below the prescribed level in their model. This, in their opinion, was bad news. So go try and convince them that at the end of the day, Harari will be laughing all the way to the bank with higher earnings per share. Over there they don’t ask about gross profit because that’s one thing that you can’t deposit. SanDisk generated $291 million from business activity in the quarter, a 39% increase over the previous year, but that wasn’t enough for some analysts.

In addition to the disappointment at the fall in gross profit, fears have resurfaced yet again of a deluge of NAND chips on the market at the beginning of 2007. In its report following the release of SanDisk’s results, CIBC World Markets called it the “the sector’s hurricane season from December through March” and it therefore advised investors to “step to the sidelines for now,” and return just before the start of the second half of 2007 which will be very strong. This was the reason that they raised their earnings per share forecast for 2007 to $3 and sales forecast to $3.9 million, despite downgrading SanDisk to “Sector Perform” from “Outperform.”

So Harari has delivered results, but not the ones that the analysts want, and when a leading investment bank like Citigroup downgrades its rating from “Buy” to “Hold” the big institutional investors dump the stock en-masse and head for the mountains. This was what caused the massive $3 billion turnover in SanDisk’s shares last Friday.

In contrast to the lukewarm recommendations from the likes of Merrill Lynch, Citigroup and CIBC, SanDisk also got enthusiastic “Buy” ratings from Bear Sterns and WR Hambrecht, which claim that in principle, this is not the time to exit the stock since this a field that has phenomenal demand, and the fears of the market being flooded with flash chips at the beginning of 2007 are exaggerated.

Published originally by Globes [online], Israel business news -
© Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.