Omrix & SanDisk: Takeover Talk Drives Volatile Trading

|
 |  Includes: JNJ, OMRI, WDC
by: Shlomi Cohen

If the 11% gain by Nasdaq in mid-July isn't a summer rally, I don't know what is. They talk about it nearly every year, and it never happens, yet this year it arrived when it was expected least, as the market continues to labor under the shadow of the crisis in the banks sector.

The rally was exceptionally pronounced on Nasdaq because of the influx of funds to tech stocks, but the climb by the Russell 2000 was higher still - 14% from mid-July as investors piled into small battered stocks of every description. The Dow Jones and the S&P 500 made do with just 6% since the cut in value taken by stocks in the energy metals, and commodities sectors was far greater than the increase contributed by the banks.

It is clear that rise in share prices was caused first and foremost by the swift collapse in oil prices, and the million dollar question is what will happen next in this sector. In recent days we have witnessed the emergence of a long overdue meeting of minds between those who couldn't understand how oil had climbed to $147 a barrel in the first place, with the world on the verge of global recession of one degree or another, and speculators who were hoping that oil would defy the slowdown and climb to $200 a barrel, but have now given up on the likelihood of this happening, because of the recession.

Today's consensus opines that a global slowdown leads to lower demand, which caused a decline in oil prices. At the same time, the idea of "decoupling" was rejected - the idea that a US slowdown can be decoupled from the rest of the world.

Tobias Levkovitch, chief US market strategist at Citigroup (NYSE:C), says that while it may sound perfectly logical to assume that with three million new consumers in emerging markets entering the consumption circle, the sky is the limit, ultimately, the economic cycles will affect them too. He says also that despite the strong growth in the East, developed countries still account for the lion's share of energy consumption.

Levkovitch claims that 37% of China's GDP is generated by export, so the slowdown now setting in at the largest importers from China, i.e. the US and Europe, will inevitably affect growth in China as well and, leading on from that, prices of oil and commodities. Levkovitch says that throughout the past few years he has maintained that it was impossible for events in the West to be detached from those in the East, and that the slowdown in the West would have a delayed affect on the East, which was why he called on investors to return home to the capital market in the US. It is now clear, says Levkovitch, that the East is slowing down as well, as a result of which the big money is heading back toward the US, strengthening the dollar in the process.

Although the clouds of recession are gradually gathering in the skies across the entire globe, Levkovitch advises his bank's institutional customers to be selective in the choice of stocks they buy since there is a good chance that things will look better for investors in the second half of the year. History shows that a collapse in oil prices always bodes well for the equities market, even if it has been triggered by the onset of a global recession, Levkovitch believes.

Levkovitch also feels that the downslide in oil and commodity prices is genuine, and not a mere technical correction, so he advises investors to tread with caution when it comes to energy and commodity stocks, even though their multiples have taken a tumble. He points out that those who bought the shares of struggling construction companies in 2006 "because they had earnings multiples of just 7" have lost 70% in the two years that have elapsed since.

Omrix and SanDisk - Up for grabs?

Two of the stocks in my portfolio tracked by "Globes", made the headlines last week, Omrix Biopharmaceuticals Ltd. (OMRI), which gained 18%, and SanDisk Corporation (SNDK), which rose 6%, both on the back of takeover rumors. As "Globes" reported yesterday, something does indeed appear to be brewing behind the scenes at Omrix. Last week's 18% gain, which means the company is now up almost 100% on its March low, was not just because of the strong results it unveiled, but is also an indication that the company is now a prime takeover target, either by way of a management buyout led by its founder and a private equity group who would then take it private, or an acquisition by its giant partner Johnson & Johnson Inc. (NYSE:JNJ).

The mixed response by analysts to Omrix's report is another sign that there was more to its rise in share price than the stronger than expected results it unveiled. The analysts at UBS, for instance, failed to be swayed by the company guidance and set a target price that is much lower than its current price on the market, $17, and reiterated their "Neutral" rating. They were joined yesterday by their colleagues at Citi, who downgraded Omrix to "Neutral" from "Buy" although they upped their target price to $23 from $20. Analysts at Oppenheimer, on the other hand, found the report encouraging, and reiterated Omrix at "Buy" and gave it the highest target price of all at $29.

As for SanDisk, it was inevitable that there would be frequent rumors that the company could be a potential merger or acquisition target. With the share now at a five-year low, and down 77% on its 52-week high, such speculation is to be expected. Last week's gathering of all the heads of the flash chip makers at the Flash Memory Summit in Santa Clara, California, provided the appropriate platform for the circulation of the latest hearsay. In a report filed from the conference on Thursday, the "EE Times" said that SanDisk's managers were in talks with Seagate Technology (NASDAQ:STX), and possibly others, over a possible sale, a report which sent SanDisk's share up 10% on exceptional volume of $250 million, with options trading on SanDisk reaching tens of thousands of calls.

Yesterday, Citi analyst Craig Ellis poured cold water on the rumor, adding that it was unsubstantiated, and reiterated his unusual "Sell" recommendation and $14 target price, below the current market price. Flash prices are continuing to nosedive, which will mean that SanDisk will face more heavy losses, and there is no good reason to assume that last Thursday's gain was actually the result of an improvement in its business. It is highly likely that there is more to it than that.

SanDisk's CEO, Dr. Eli Harari said himself, on the evening before the rumor was reported in the press, that the market was going through a tough period and that this could last for some time, but he believes that eventually - perhaps from 2010 onward - demand will be so high that the flash industry will need to build another 10 mega-size fabs within five years to meet that demand, most of which will be for memories for handsets and computers. I believe that if SanDisk is indeed talking to possible buyers, it stems, among other things, from Harari's desire to hand over the reigns to someone younger than him, since SanDisk will face a trying time in the next few years should it remain independent.

It is my belief that there could well be some serious talks involving Toshiba (OTCPK:TOSBF), SanDisk, Seagate and maybe even Samsung (which will be looking to secure future royalty agreements) which will ultimately lead to the selling of SanDisk's flash production lines back to its partner, Toshiba, with the other company businesses merged with Seagate. Seagate, the leader of the hard drive industry, knows only too well that the industry's future lies in flash-based Solid State Drives [SSDs], and that joining forces with SanDisk could create an SSD juggernaut that would be more than a match for Intel Corporation (NASDAQ:INTC), Toshiba, Samsung, and the others. In addition, a merger like this would also give it an opportunity to diversify into the burgeoning handset niche.

Disclosure: None

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

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