Summary from WHQ below. Full pdf report at openreit.com
02.22.07 sndk: CURRENT IP ROYALTY RUN RATE IS AT RISK AS SAMSUNG PULLS A FAST ONE - DOWNGRADING TO HOLD FROM BUY
We are downgrading SanDisk from a Buy to a Hold rating. We have always believed that one of the most important factors in the SanDisk business model has been the IP story and that as long as this has stayed stable, we believe that SanDisk stock would be able to weather the storm of the current pricing environment with a floor valuation at ~$40. However, in recent days we have learned that a crack in the IP story has occurred, as Samsung has found a way to significantly reduce its royalty payments to SanDisk on its finished SD cards that it is currently shipping. Our analysis is that this step by Samsung is to put at risk ~15% of SanDisk royalty revenues as early as Q2:07, as Samsung is no longer willing to pay the 8% royalty rate to SanDisk on NAND MLC SD cards. While the outcome of this step is unclear, we have attempted to quantify this and therefore at this stage feel that investors in SNDK should be aware that the IP story has its risk. Therefore, we are taking a cautious approach and lowering our royalty revenues from $373M to $327M for 2007, and $500M to $405M for 2008. We are adjusting our pro forma EPS estimate for 2007 from $1.74 to $1.61, which is lower than the current Street estimate of $1.82. Due to the risk in the royalty stream and the lack of pricing leverage in the next few quarters, we do not anticipate positive catalysts in the stock in the near future. Our sum-of-parts valuation thesis supports a stock price of $37. While we are aware that this is a controversial call, as pricing may be close to bottoming, we have growing concern that estimates on the Street could move lower if our Samsung IP thesis plays out. Therefore, at the current risk-reward scenario, we recommend investors to move to the sidelines and wait for a better entry point into the name. Full Report - PDF
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