SanDisk: Flash Behind the Chinese Wall

The last time SanDisk Corporation's (SNDK) share price collapsed, I wrote that the fact that it had fallen meant that there was serious risk that the shark that swallowed the goldfish, in this case m-systems, would be in turn swallowed by an even larger predator.

On Friday, Samsung Electronics Co. Ltd. (KSX:5930) - a company worth $75 billion - officially confirmed that it had engaged a top flight US investment bank, JP Morgan (JPM), to "look at a variety of business opportunities." SanDisk, for its part, put out an official announcement of its own in which it said it "periodically has conversations with multiple parties, including Samsung, regarding a variety of potential business opportunities", and that it would make no further comment on rumors.

I would interpret the SanDisk announcement as the first confirmation from it that there have been talks with Samsung, but it may well be that they dealt solely with the renewal of the royalties agreement between the two in the summer of 2009, and as far as the company's despondent investors are concerned, even this trivial matter, as it were, is a like warm ray of sunlight at the height of a freezing winter.

I believe that in its announcement last Friday, Samsung actually confirmed for the first time, albeit indirectly, that it would have to sign a new royalties contract with SanDisk, given that it has virtually no other need for partnership with it. In my estimate, the 31% gain in the share on nearly $1 billion turnover is merely an advance, reflecting the value of this indirect disclosure alone.

A read of all the analyst reports covering SanDisk confirms indirectly that despite the Chinese walls that are supposed to prevent analysts from finding out what mergers and acquisitions could be on the cards in the companies they cover, there are apparently still a few peepholes here and there. I found that of all the analysts I have read over the last few days, the teams at Goldman Sachs, both the American one covering SanDisk and the Korean covering Samsung, are the only ones that have stated unequivocally that an acquisition of SanDisk by Samsung would be a highly profitable and logical deal for Samsung.

Furthermore, after SanDisk's recent grim results and guidance, and with semiconductor prices continuing to nosedive, the Goldman Sachs analysts were the only ones to give the company a "Buy" recommendation and a target price of $30, which is high. Goldman Sachs is known to have acted as bankers for SanDisk in the past, the last deal being the m-systems acquisition just over a year ago.

A desperate call for a knight on white horse

With everyone referring to the $4-5 billion in potential royalties that Samsung is understood to be due to pay SanDisk as the main incentive for acquiring it, Goldman Sachs's Korean analysts have drawn our attention to another key asset that we have apparently overlooked - the SanDisk brand. According to them, Samsung has had its fill of the constant volatility in flash chip prices, and it is now looking to expand rapidly into the end products market, specifically flash cards.

The name SanDisk, as a flash card brand, is now essentially the default choice when buying flash memory cards for digital cameras and handsets at more than 200,000 sales points worldwide, where the company has a presence. Samsung has never managed to become a significant player in the end-user market, even though it now sells all the products that SanDisk offers, from cards to USB drives and media players.

In addition, SanDisk has an enormous pool of patents and technologies, most of which have not yet been commercialized, and on which it is also expected to earn royalties in the future. Samsung, like every other flash player, would love to get its hands on x4, for example, developed at m-systems, and D3, which was developed on the basis of the technology of a start-up it acquired several years ago. The latter, which many people may view as a burden today, but which will have a phenomenal value the moment the chip market sees a spike in demand, is part of a joint flash production venture in Japan with Toshiba (TOSBF.PK).

SanDisk's close ties with Toshiba have led analysts, such as Craig Ellis of Citi, to pour cold water on the rumors of an acquisition by Samsung, which they feel amounts to maneuvering by Samsung as part of the negotiations on royalties in the new agreement. Ellis is so skeptical, that in a further move to steer his clients clear of the share, he cut his target price for SanDisk again to $13, and reiterated his "Sell" recommendation, even though the share is currently traded above $17.

With Toshiba valued at $16.5 billion, compared with the $75 billion value for Samsung, I would not underestimate Samsung's desire and ability to break up the historic partnership between SanDisk and Toshiba, especially with SanDisk's frustrated investors who hold 98% of the company hovering in the background. Toshiba's only chance of preventing this is, I feel, a desperate appeal for a knight on a white horse that will save it from Samsung, and the only type of company that could fill that role is a giant such as Intel Corporation (INTC).

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.