SAN FRANCISCO Amid questions about royalties from Samsung Electronics Co. Ltd., embattled SanDisk Corp. told analysts earlier this week that the company plans to place emphasis on being a vertically integrated consumer electronics supplier, according to sources who attended the company's analyst day Monday (Feb. 26). Analysts appear divided on the wisdom of the strategy.
Alex Gauna, an analyst with UBS Securities LLC, wrote in a research note published Tuesday that SanDisk described a new strategy of "becoming a vertically integrated consumer electronics powerhouse," moving away from its core competency of semiconductor engineering. "This strikes us as a very risky departure," Gauna wrote.
"I have my questions on that and what it means to the margin structure of the company," Gauna said in an interview. At the analyst day, he added, the company showed its gross margin figure compared to some premium companies that play in the consumer electronics space, such as Apple, Nokia and Motorola, in an attempt to show that the SanDisk has a premium gross margin comparatively. "My concern is that if they move farther down that road [toward becoming a vertically integrated consumer electronics vendor] their margins will diminish further."
But Satya Chillara, an analyst with Pacific Growth Equities LLC, disagreed, saying in an interview with EE Times that SanDisk's step toward the consumer electronics arena is "nothing new" and a "the right direction" for the company.
"I agree that the company is transforming more and more into a consumer electronics company," Chillara said. "But I think the key is that SanDisk has the NAND flash competency to compete with consumer electronics products based on NAND flash."
Chillara noted that SanDisk has already been offering consumer electronics devices, citing the company's introduction of several handheld multimedia and MP3 players at the Consumer Electronics Show in January. Chillara said he does not expect SanDisk to diverge into consumer electronics beyond those that emphasize NAND.
SanDisk, Gauna said, has demonstrated that it can be a brilliant technology company and brilliant semiconductor company. But the company has not necessarily distinguished itself as a brilliant end product company or brilliant marketer, he added. "When you look at some of what I would say are the brilliant marketing campaigns put together by companies like Apple and Motorola, we haven't seen SanDisk demonstrate any of that ability to date."
Responding to the rapid deterioration of NAND flash prices in recent months, SanDisk announced Feb. 16 a series of cost-cutting moves, including reduction of its global workforce by about 10 percent and decreasing salaries for all executives by 10-20 percent. Analysts have forecast that NAND prices could tumble by 65 percent overall this year, after dropping by about 60 percent in 2006.
SanDisk Monday forecast a decline in the average selling prices (ASPs) of its overall product line of more than 55 percent in 2007, according to analyst reports. SanDisk forecast bit growth of greater than 170 percent for the year, but Gauna noted that the company's projected gross margin of 15 to 25 percent is "well below" UBS' estimate of 29 percent and "down sharply" from 31.8 percent in 2006 and 35.5 percent in 2005.
Based on updates to bit and ASP guidance, Gauna increased estimates for SanDisk's 2007 revenue to $3.83 billion from $3.72 billion and for 2008 revenue to $4.57 billion from $4.27 billion However, Gauna also decreased his estimates for SanDisk's pro forma earning-per-share for both years. Following the meeting, Gauna maintained UBS' "neutral" rating on SanDisk's stock following the meeting.
Chillara, meanwhile, maintains a "buy" rating on SanDisk's stock and remains bullish on the prospects for the company in the near future and longer term. When SanDisk initiates production of three- and four-bit-per-cell NAND both of which he expects to occur before the end of 2007 SanDisk "will be the only company that can withstand pricing declines of 50 percent of more in 2008/09, which is assuming the worst case scenario," Chillara wrote in a research note published Tuesday.
Chillara wrote that Pacific growth believes that the near-term seasonality and NAND demand problem should pass by the end of the year and that the second half of 2007 and 2008 represent potential upside for SanDisk's stock. Both Gauna and Chillara noted that SanDisk maintains a healthy balance sheet despite ASP challenges, and Chillara called the company's 2007 capital expenditure plan "benign" compared with 2006 and said the company has saved up to $1 billion through efficiencies and increased wafer production.
Chillara said in the interview that SanDisk presented "a very clear strategy" at analyst day. "The stakes are very high, and 2008 and 2009 will be a very big differentiator, with demand coming back," Chillara said.
On another front, analysts from WR Hambrecht and Co. downgraded the firm's rating on SanDisk to "hold" from "buy" on Feb. 22, citing concern that Samsung would attempt to reduce the royalty payments. The firm reduced its estimates for SanDisk royalty revenue for 2007 and 2008 by $46 million and $96 million, respectively, as a result.
But Chillara downplayed the report and the potential risk for SanDisk, saying that royalties paid to SanDisk on chips are completely separate from the portion of royalties it receives from the SD Card Association, which it co-founded. SanDisk, Chillara said, receives only $2 million to $3 million total per quarter from SD card royalties, while it pockets $90 million to $100 million per quarter from chip royalties paid by Samsung. While Samsung could take issue with royalty payments to SanDisk on both chips and cards, Chillara said, he does not believe the arrangement is likely to change based on an established 2002 agreement between the two companies.
Gauna said SanDisk has subtly changed the way it talks about those royalties and acknowledged that royalty rates will account for a diminishing portion of the company's revenue. "We now have what I consider to be admission from the company that it is under pressure from Samsung to reduce those royalty rates," he said.
A spokesman for SanDisk (Milpitas, Calif.) declined to comment on the report that Samsung would attempt to change the structure of royalty payments on SD flash memory cards, citing company policy not to comment on royalties or break out royalty revenue by specific customers. The SD Card Association did not immediately respond to request for comment.
SanDisk's stock value tumbled 8 percent in the days following the Feb. 16 cost-cutting announcement. SanDisk closed at $36.91 in Nasdaq trading on Tuesday.