SanDisk Corporation and the Apple Inc. Opportunity?


SanDisk Corporation (NASDAQ:SDNK) was founded in 1988 by Dr Eli Harari who remained Chairman and CEO until the end of 2010. The company is a world class, pure play, technological innovator in NAND flash memory storage which is used in a wide range of devices for which traditional spinning disk storage isn’t appropriate such as digital cameras, USB drives, tablets, smartphones and certain high end laptops. The company also receives royalty streams from various competitors such as Samsung for the use of their technology.

I first came across SanDisk Corporation (NASDAQ:SDNK)  when researching the industry of a previous holding Western Digital, but I didn’t dig too deeply until I saw it mentioned in the T2 Partners year end letter as one of their top 10 holdings. Of course the reason that Western Digital was so cheap was because the HDD business is in secular decline, mostly because of the increasing capacity and affordability of the products produced by SanDisk and its peers.

SanDisk stock presents an excellent buying opportunity because the current price meaningfully underestimates the future cash flow potential of a company that is intertwined as a vital facilitator in the growth industry of smartphones, tablets and increased data storage globally in enterprise and in our private lives. I view SanDisk as a high quality Growth at a Reasonable Price idea. It is also a “Magic Formula Stock” which means that it is attractive on a purely quantitative basis. I can see the stock trading well into the $60-70 range over the next year or two offering 50-70% upside.

You probably recognise the name from memory cards for your digital camera or USB stick but that was the SanDisk of 2008, the rest of the world has begun to catch up to their technology which is increasingly embedded in all high end computer devices.

Product Descriptions

Imagine 128GB of memory inhabiting something smaller than a penny. SanDisk has just made it a reality, in its relentless, market leading pursuit of better, smaller, faster flash memory storage solutions.

SanDisk specialises in NAND Memory which is a type of non-volatile storage technology that does not require power to retain data. NAND flash has found a market in devices to which large files are frequently uploaded and replaced. Mp3 players, digital cameras and USB drives use NAND flash. Flash memory is much more expensive than traditional HDD memory, but it is more compact, durable, offers faster access and uses less power, so its usage has grown dramatically with the proliferation of mobile computing and the increasing sophistication of peripheral electronic gadgets. A consensus is emerging that flash drives will be used for requirements of speed and power efficiency and older HDD’s will be used for needs of capacity. Online transactional processes and high frequency trading are two good real world examples where SSD has a functional advantage worth paying for.

To quote Whitney Tilson in T2 Partners year end letter…

“Historically, the flash memory business has been commodity-like, with chronic excess capacity and rapidly declining prices. Due to industry consolidation and explosive growth in end demand, however, we think SanDisk is on the verge of very strong secular growth, with improving margins, which should lead to explosive profit growth and a meaningful revaluation of the stock. The best stocks are ones that combine high earnings growth and an expanding multiple on those earnings, and we think SanDisk is poised for both.”

SanDisk is an industry leader and has two very important strengths that should lead it to sustained success: its distribution channels and its low cost leadership. First, it has a strong global reach with 57 percent of its sales being international and has at least a 28 percent market share in all parts of the world including a 34 percent market share in the United States and a 32 percent market share in Europe. Second, the company has a lot of relationships with consumer hardware companies including Apple, Samsung, HP, Dell, Nokia, Motorola, and HTC.

When these companies’ products are bought, they come embedded with a SanDisk storage device, so consumers become familiar with the SanDisk brand and are more likely to use the SanDisk memory devices. Third, the company’s products have a very strong retail presence. SanDisk reports that its products are available at over 250,000 stores worldwide and are available at 19 of the top 20 consumer electronics retailers in the United States.

SanDisk is able to use its high cash flow and position at the front of the market to fund research to cut costs and stay ahead of its competitors. This way, it can outprice them, maintain and expand on its market share, and increase revenues and profits.

Industry Summary

The NAND market is mature and oligopolistic with a few major players dominating supply (Samsung, SanDisk, Micron and Hynix). Furthermore Apple currently constitutes around 30% of global demand for NAND storage and has the influence to move prices based on their new product releases.

The NAND market has doubled in size in the past 5 years, going from $12bn in 2006 to $25bn in 2011. The multi-year growth story looks likely to continue due to growing demand from smartphones, tablets, notebooks etc.

To emphasize the rate of change and growth we are seeing here, we can pretty much say that tablets didn’t exist 3 years ago and now they are an integral part of many lives.

A slide below with a selection of consumer end products that SanDisk memory is embedded within.

SanDisk is probably the industry leader for innovation and technology as evidenced by their being the first to produce sub 20nm scale of miniaturization, something which was previously thought impossible. The jargon at this point begins to bamboozle me but I read that they were the first to design, patent and sell a “4 bit per cell architecture at 43nm node” and that a greater proportion of their production and sales are done at the cutting edge of technology than their peers. This is demonstrated in the use of their “X3 Technology” which has a 15-20% cost advantage over what the competitors are using and is in around 50% of SNDK production.

One of the biggest concerns to pricing power in the industry is that supply outstrips demand, due to a downturn or exuberant expansion of capacity from suppliers. Pricing is volatile in these markets and this was one of the problems faced by HDD producers leading to volatile quarterly earnings. The participants in the NAND market appear to be behaving rationally and all are talking about cautious expansion of capacity in line with demand and no-one seems willing to slash prices to take market share. On top of this, only SanDisk (35%) and Samsung (40%) have sufficient scale to materially affect the capacity growth of

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