Sunday, October 22, 2006

SanDisk (SNDK) Analysis

We looked at Sandisk and other flash manufacturers in the attached article. In that article, we noted

"In this article, we take a quick look at some of the flash memory manufacturers
and the trends in this area. Some of the companies in the flash memory area are
- Sandisk (SNDK), Micron Technology (MU), Lexar Media Inc ( LEXR ), Infineon,
Samsung and Toshiba. Samsung mainly makes deals with OEMs and doesnt deal with
retail marketing. We will analyze a couple of companies and SNDK in this

In the intervening months, the usage of flash memory has increased. It is used more commonly now and the volume is growing. Along with the volume, the cost per memory unit is declining. Meanwhile, the industry is consolidating. This is a very competitive business with many players. Meanwhile, the business is also consolidating with Lexar going private and Sandisk buying the Israeli based M Systems. Eli Harari, the CEO of SNDK estimates a growth of 200% in flash memory volume in 2006 compared to 2005.

Most of the electronic equipments get sold in the holiday season. Consequently the last quarter of the year is a big one for flash/memory manufacturers as well. As much as 40% of Sandisk's business occurs in the fourth quarter. Sandisk as a company is the leading provider of flash memory in the world and has done well to expand its base. SNDK has diversified into MP3 players and have cornered 10% of the market - a market dominated by Apple's iPod.

Next we will look into SanDisk's operarting margins. For the three months ended in July, the operating margin was 13.29%. ( net income/total revenues ). This was about 13.69% for the same period the year before. For the first six months, the operating margin is 13.89% - this compares to a margin of 22.73% in the same period the year before. Now let us move to this quarter - the operating margin this quarter was 13.74% where as the margin was 18.22% in the same quarter a year before. So clearly, the trend is for the margins to go down year over year. The cause for the margins to decline is primarily attributed to a glut in the Flash market where one of the manufacturers oversupplied the market.

Another important metric is the free cash flow. The company's free cash flow has been going up and down over the past ten years. Specifically, in the past four years, the numbers are 217 million, 101 million, 347 million and 241 million for this year respectively. So the cash flows are erratic and this typically means the company doesnt have market dominating power.

Another metric of interest in the high tech companies is the stock dilution year over year. Year over year, the dilution is about 4% and is expected to be much higher once the all stock deal closes for Israeli based MSystems Limited.

The stock dropped by over 20% on Friday last week because of the declining margins sited by the CEO - Eli Harari. There are two types of valuations that can be done - one is relative valuation where a company is compared to its peers in the same sector and the second is by looking at the future discounted cash flows to see the intrinsic value. In the technology sector, primarily the relative valuation approach works best. The intrinsic valuation approach doesnt work as well as one would find that the stocks are typically overpriced with huge expectations for future growth.

Doing relative analysis, one finds that SNDK is fairly priced with Friday's drop and probably can go up a bit to the $56 range. The comparison of SNDK is with Micron Technology and SNDK should enjoy a slight premium because of bette margins and its market leading position.

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