M Systems Flash Disk Pioneers Ltd. (FLSH)

[midastouch017]

M-Systems has a blockbuster, too

CEO Dov Moran: MegaSIM is the story of 2007 and onwards.

Gitit Pincas 20 Feb 06 17:19

M-Systems Flash Disk Pioneers Ltd. (Nasdaq:FLSH) fired off no less than 14 press releases during the 3GSM World Congress 2006 exhibition in Barcelona last week. The quantity of press releases might appear overwhelming at first glance, and presumably not every investor read them all, but hidden within were very interesting developments about the company and its highly publicized launch of MegaSIM. MegaSIM is technology that enhances SIM memory cards in order to boost the revenue of the world’s mobile network operators (MNOs).
The concept underlying MegaSIM is to provide more customer services, thereby boosting traffic, recruiting more subscribers, getting new business orders from MNOs, which will generate revenue for M-Systems. This is a huge market, given that over 1.5 billion SIM cards are sold annually. How much revenue will M-Systems accrue? That is hard to know, but to borrow a concept from pharmaceuticals, M-Systems very probably has another blockbuster in a market worth $1 billion or more. The company already invented a $1 billion market with its DiskOnKey (DOK), and the market for its MobileDiskOnChip (MDOC), a processor designed for handsets, has also reached this size.

“We hope for more than $50 million”

How was the 3GSM World Congress? “This industry is amazing, said M-Systems president and CEO Dov Moran after the conference. “Regrettably, I barely had time to walk around the exhibition, because we had so much work. Everyone will tell you that his pavilion was amazing, but M-Systems’ pavilion was truly awesome. Ask the other people who were there. We had two conference rooms that were constantly full. We had a lot of action. It was real fun. We got excellent responses to the products we launched.”

M-Systems is very serious about wireless, which is why it set up its fourth division -MNO - a new profit center whose gala was the 3GSM World Congress. MegaSIM is new, but the company is no stranger to wireless. Since 2001, M-Systems has sold millions of processors for handsets to six of the world’s seven leading manufacturers.

Let’s try to summarize M-Systems’ announcements, not necessary in order of importance. The company first announced its road map for its MegaSIM launch, a timetable that already includes the acquisition of Microelectronica Espanola, its new Spanish smart card subsidiary.

MegaSIM is already being used in pilots with major wireless operators, and commercial orders will begin during the third quarter. Initial orders will be for a 512-megabyte card, with a 1-gigabyte card following by the end of 2006. A series of 2-gigabyte and 3-gigabyte cards will be developed later this year. For the sake of comparison, a 512-megabyte MegaSIM card - the lowest capacity card - has 8,000 times the memory capacity of the standard 64-kilobyte SIM card.

M-Systems also announced a partnership to launch the world’s first 512-megabyte high-density SIM card with Oberthur Card Systems (Euronext:124133). Oberthur will sell the SIM card with M-Systems’ platform to Orange, the first operator to use it. Deployment will begin in France, initially on LG U8210 handsets, and will later spread to other countries and handsets.

Moran said, “Most of our future agreements are in this direction. Orange is buying MegaSIM through Oberthur, which buys from us, thereby making it possible to offer customers new services, such as music, games, and so on. The new division was established with a focus and the realization that it will have millions of dollars in sales of products to wireless within a few years.”

“Globes”: Is MegaSIM a story for 2007 only, or also for 2006?

Moran: “We’re just getting started. Look, we had $540 million in sales last year, so we probably won’t have $100 million this year, but it’s a very good start.”

A new report by Nollenberger Capital Partners analyst Casey Ryan states, “The products series and partnerships announced by M-Systems during the 3GSM World Congress are likely to boost the company’s revenue and profits more quickly than we expected. We expect that the company can even record more than $50 million revenue from its MegaSIM product line in 2007.”

Moran, your response please: is $50 million in line?

“We’re not providing further guidance about MegaSIM, but I’m prepared to say that I hope that for even more than $50 million [in sales] in 2007.”

As usual in launches of this kind, M-Systems has a slew of applications marketing and distribution agreements, some of which are only at the feasibility study stage, while others are already available for customers. Partners include wireless anti-virus program developers such as F-Secure (HEX: FSC1V), which protects content, McAfee Inc. (NYSE:MFE), which blocks unwanted files, and RSA Security (Nasdaq:RSAS), which provides a higher level of security; video applications companies, such as Actimagine, which preserves high-resolution rich content on cards; Picsel Technologies Ltd. for the viewing of, and interaction with, rich content on small screen devices; Secure Digital Container (SDC), a company that manages intellectual property rights for music files and games; Openbit Ltd. for licensing services for conditional access to licensed applications, such as games; and PowerHouse Technologies Group Inc., dba Migo Software (Nasdaq: PWHT.OB), which gives subscribers the ability to store, secure and synchronize their documents, computing profile, e-mail and Internet browser favorites using their mobile handsets, ultimately enabling smarter mobile services. This is indeed a varied and interesting range of partnerships.

In a conference call, you spoke about interesting future developments. You said the company would announce innovative and breakthrough technology during 2006. What are you talking about?

“I can’t divulge additional details at this time, except to say that this is breakthrough technology. Wait and see.”

In recent weeks, M-Systems has been changing its product names, as well as the company name, removing “Flash Disk Pioneers”, leaving only “M-Systems”.

“We changed our logo,” says Moran. “It was always said that the logo looked as if it had been copied from Merkavim Metal Works Ltd., with all those triangles. That will no longer happen. In addition, we changed our name, which was necessary. It used to include the word “Pioneers”, which always reminded me of some village in the Galilee. We don’t work with hoes; the word no longer seems relevant for us.”

These changes do not appear on M-Systems’ website.

M-Systems also changed the name of products to include the prefix “M”. “We analyzed the entire company and its products, and realized that we needed to be perceived more like one big company, rather than a group of divisions,” says Moran to explain the rationale. DiskOnKey will now be called M-Drive, and DiskOnChip will become M-DOC.

So you’ve given up the near-generic name DiskOnKey?

“It has really become generic, but we don’t sell the product under this name anyway. We only sell via companies that give their own labels to DiskOnKey. The truth is that I have a registered trademark on DiskOnKey, but that’s unimportant.”

M-Systems’ market cap exceeds $1 billion. Some shareholders exploited the share’s recent weakness - the publication of its financial report caused an immediate 11.4% drop in the share price - to increase their holdings in the company. According reports to the US Securities and Exchange Commission (SEC), Massachusetts Financial Securities Company (MFS) increased its stake from 4% at the end of 2005 to 8.3%, and Eastbourne Capital Management LLC increased its stake from less than 8% at the end of 2005 to 9.9%. On the other hand, RS Investments reduced its holding from around 8% in 2005 to 5.6%.

“We definitely want investment institutions to own larger stakes in the company, because they better understand our business, rather than opportunistic investors, who understand us less,” says Moran. Is he hinting to the fall in M-Systems’s share after it published its results for the fourth quarter of 2005 and the year as a whole? The company released excellent numbers for 2005, when it posted a profit of $52.6 million on $539.9 million revenue, and its guidance for the first quarter of 2006 calls for $140-170 million revenue. “Yes,” says Moran. “Logic says that more institutions will prevent such falls.”

Institutional or private investors - it’s hard to always find reasons for the market’s behavior, and Moran knows this. Do you want an example? Look at what happened to Lexar Media Inc. (Nasdaq:LEXR) last week. Lexar operates in M-Systems’ market and competes against SanDisk Corporation (Nasdaq:SNDK), making NAND flash memory products that include memory cards and DiskOnKey. On February 13, with no particular pangs of conscience at the especially late date, the company announced that it would post $240-245 million revenue for the fourth quarter of 2005, below forecasts. Lexar will lose $17-21 million for the quarter that is normally the industry’s strongest. Please note that the gross profit margin is 6-8%. Lexar chose not to hold a conference call about its severe profit warning, and will only hold one on March 6, when it publishes its financial report.

How did Lexar’s share react? Although there still no numbers, and preliminary figures are no source of joy for investors, the share subsequently rose 2.5%, and has risen by 5.3% since last week’s profit warning. Who says that market behavior can be predicted?

Published by Globes [online], Israel business news - www.globes.co.il - on February 20, 2006

http://www.globes.co.il/serveen/globes/DocView.asp?did=1000063613&fid=980

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