SanDisk Corp. (SNDK)

[chmcnfunds]

SanDisk Setting Up For Positive Surprises
February 15, 2012

We believe SanDisk (SNDK) offers a compelling risk/reward profile, with several upcoming catalysts following the company's recent earnings disappointment.

When SanDisk reported its 4Q results on January 25th, the outlook was poorly received, with shares trading off 11.4%. Since then, it was reported SanDisk was cutting prices by 15% - in our view, a non-story, since SanDisk had already indicated they expected 1Q pricing to be soft.

With shares trading at just over 6x 2012 EPS ex-cash (SanDisk has approximately $16 per share of net cash), we believe the deck has been cleared on bad news, and the company is set for upside surprises.

We outline below several positive catalysts:

SanDisk analyst day - On February 16th SanDisk will host its annual analyst day. With the bad news out of the way, it should be a generally upbeat day, with lots of excitement regarding the mainstream enterprise adoption of SSDs (solid-state drives). SanDisk CEO Sanjay Malhotra indicated that 2H12 will be the inflection point for SSDs so we anticipate a good deal of discussion regarding that opportunity. We believe that to the extent the company discusses NAND supply/demand dynamics, they will be more upbeat than on the 4Q call.

Firming DRAM helps NAND - With SanDisk's price cut in the rearview, we expect better NAND pricing (or at least slower price degradation) over the course of 2012. We believe recent troubles in the DRAM industry, including the potential bankruptcy of Elpida, will result in firming DRAM prices - a positive for Micron (MU), which, in anticipation of better pricing, has been trading dramatically higher (up 32%) year-to-date. Given the fungibility of DRAM/NAND capacity, a better DRAM price environment diminishes the motivation to shift DRAM capacity to NAND, and, on the margin, helps NAND pricing.

Apple introductions - We expect the introduction of iPad3 and later this year, new flash drive only notebooks to drive excitement and demand in the flash sector. We would anticipate that notebook/ultrabook manufacturers will quickly have to react to Apple's introductions, driving additional demand - also, clearly a negative for Seagate (STX) and Western Digital (WDC).

Turning on Fab 5 - CFO Judy Bruner spoke at length on the 4Q call that Fab 5 would turn on no earlier than July. We expect that SanDisk will turn Fab 5 on in July, and when that news breaks, likely several months in advance, we anticipate a further positive reaction.

We believe shares have about a 10% downside/60% upside over the next 6-9 months, at current levels. At 10% down, we'd expect the company to aggressively repurchase shares creating a floor in the stock, while 60% upside represents multiple expansion to 10x CY13 EPS plus cash. We would prefer to see the company in the market, aggressively repurchasing shares today - it would be massively accretive to earnings.

While we have a favorable view on shares, we have one fairly meaningful concern. We were surprised by how emphatic management was about pushing out Fab 5. Historically, former CEO and co-founder Eli Harari spoke tirelessly about the price elasticity of NAND. Lower prices spurred adoption and opened new markets, and also shifted consumers to using higher capacities (ie a 4GB card instead of a 2GB card). If capacity came on too soon, it would result in a weak period followed by an explosive period. Perhaps we are reading too much into it, and SanDisk is merely timing the market. It's just somewhat strange that SanDisk wouldn't be prepared with more internal capacity in front of an "inflection point" for SSDs.

This is something we'll monitor closely. Nonetheless, with shares at current levels, we believe the risk/reward is too compelling not to own.

Disclosure: I am long SNDK.
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