SanDisk - Acquisition Of Fusion-Io Gives Company Strong Foothold In Enterprise SSD Market

Jun.17.14 | About: Western Digital (WDC)

Summary

SanDisk announces the acquisition of Fusion-io, boosting the presence in the attractive enterprise SSD market.

The company is able to acquire the troubled Fusion-io at relatively attractive prices, with shares trading down 70% from their highs.

I am cautious after its runaway momentum, despite the fair valuation, growth prospects and strong financial position.

SanDisk (SNDK) was one of the participants in this version of merger Monday, announcing the acquisition of Fusion-io, thereby boosting its presence in the enterprise SSD market.

The strategic deal makes great sense, as SanDisk is able to buy the problematic company at a modest premium, with shares of Fusion-Io trading with losses greater than 70% from the highs set around $40 in 2011.

Yet, after the runaway momentum, I am a bit cautious for SanDisk, despite a fair valuation, strong track record and solid financial position.

The Deal Highlights

SanDisk announced that it has entered into a definitive agreement to acquire Fusion-io (NYSE:FIO). The company will acquire the developer of flash-based PCIe hardware and software solutions which enhances the performance of applications in a $1.2 billion all-cash transaction.

Net of cash held by Fusion-io, SanDisk will pay $1.1 billion for the company, or $11.25 per share in cash. The offer marks a 21% premium over Friday's closing price, and implies a premium of about $200 million in actual dollar terms.

The deal has been approved by the board of directors of both companies, and is expected to close in the third quarter of SanDisk's fiscal year. The deal is expected to be accretive to non-GAAP earnings in the second half of 2015.

Strategic Rationale

With the acquisition of Fusion-io, SanDisk is able to accelerate efforts to enable the flash-transformed data center, allowing companies to better manage their heavy data workloads at a lower total cost of ownership.

The $1.1 billion deal can easily be paid out of SanDisk's comfortable cash balances. The transaction values Fusion-io at approximately 2.8 times trailing annual revenues of $387 million. Note that the company posted a $104 million loss over the past trailing year.

Recent Investor Day

Back in May, SanDisk held its investor presentation. Various secular trends are expected to drive the need for NAND flash in the future. Some of these supporting trends are buzzwords like Big Data, cloud computing, social networks, analytics, smart devices and Internet of Things, among others.

The usage of NAND comes at a lower total cost of ownership, while it delivers instant and real-time results. It furthermore requires less power, cooling and space, while it is flexible to configure.

Between 2013 and 2017, SanDisk anticipates the total addressable market for enterprise solid-state drives to increase by more than $5 billion to little over $8 billion.

The total addressable market, including client SSDs, embedded and removables, is expected to grow by some $12 billion to $41 billion. This just shows that the vast majority of incremental growth is expected to occur in enterprise SSDs. It is exactly this market on which Fusion-io has focused itself.

Valuing SanDisk

SanDisk ended the first quarter with $2.81 billion in cash, equivalents and marketable securities. The company holds another $3.51 billion in long-term marketable securities, resulting in net "cash" holdings of $6.32 billion. The company has $2.01 billion in total convertible debt outstanding, resulting in a $4.31 billion net cash position.

For the current year, SanDisk anticipates revenues to come in between $6.4 and $6.8 billion. Non-GAAP operating margins of 27% to 31% are similar to the 29% margins reported last year. Earnings are seen around $1.2 billion on a GAAP basis.

Shares rose to levels above the $100 mark following the announcement of the acquisition, valuing SanDisk around $23 billion at $102 per share. This values operating assets at close to $19 billion, which values operating assets at 2.9 times annual revenues and 15-16 times annual earnings.

SanDisk pays a quarterly dividend of $0.225 per share for an annual dividend yield of 0.9%.

Momentum Continues

On the back of the announced deal, shares have risen another 3%, taking out new highs above the $100 mark. The reported $1.1 billion deal tag is very modest, representing roughly 5% of SanDisk's own market valuation, while the deal will add roughly 6% in annual revenues.

On the back of this year's momentum and deals being announced in the industry, shares have risen sharply in recent times. So far in 2014, shares are up by 44%, after shares have risen about 73% compared to last year.

The valuation at 15-16 times earnings seems fair given the rock-solid balance sheet, the overall high valuation of the stock market and the impressive track record over the past decade. Between 2004 and 2013, SanDisk has grown its revenues at an annual rate of roughly 15% per annum. Earnings have grown at pace as well, while total dilution of 20% over the entire time frame has been limited.

The latest deal is of greater importance than simply adding some revenues. With Fusion-io, SanDisk gains a stronger foothold in data centers, the fast-growing segment of the market. These flash-memory based chips are faster and cheaper than conventional chips to be used by firms. The company will compete in the market with the likes of EMC Corp. (EMC) and Hewlett-Packard (NYSE:HPQ), as well as new entrants, which could pressure margins in the future.

Given the strong momentum, I am a bit cautious, despite an excellent deal, a strong track record, a fair valuation and a strong balance sheet. I will remain on the sidelines but reevaluate my stance on serious corrections.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.