Morningstar Notes
Nothing new, but the valuation metrics are interesting.
"
...
Spansion is the largest, most innovative player in the NOR
flash memory market. We like its technical and market
position and believe that it will grow even stronger.
However, its market is a hotly contested one that regularly
sees drastic reductions in selling prices. We would
approach an investment in Spansion with caution,
understanding that the share price is likely to be volatile
over the short term.
NOR flash is optimized to store and run operating
instructions for electronic devices; more than half of
combined market sales are to mobile phone handset
makers. NOR's better-known cousin, NAND flash, is
optimized for data--rather than code--storage and has
become ubiquitous as a cheap and easy medium on which
to store MP3 music files, documents, and other digital
files. Because NOR flash is used to store small programs
(such as the operating system that allows a mobile phone
to operate), storage densities for NOR chips tend to be
much lower than those for NAND. The two technologies
are very different. NAND can be combined with DRAM (a
standard memory found in personal computers) to function
like NOR, but NOR is inherently quicker and more accurate
when running code.
Spansion only went public in 2005, but it has been in the
NOR business for a long time. Since being spun off from
Advanced Micro Devices and Fujitsu, it quickly increased
its market share and took the title of number-one NOR
flash manufacturer from Intel in late 2005. It has been
extremely innovative in its product development and,
through a strategic partnership with Israeli chip designer
Saifun, has developed a version of high-density NOR that
can double as NAND-like data storage while retaining
NOR's traditional strength in storing code. Spansion has
also been increasing its operating efficiency by building
plants that manufacture at higher capacities and lower
cost than competitors' factories. While high, these expenditures will translate into a cost advantage for
Spansion over the next several years, in our opinion.
Another key to Spansion's success has been its customer
support. NOR memory interacts with device hardware, and
as such, device designers tend to optimize devices to work
with a particular NOR configuration. Once a NOR
component is designed into a device, it tends to have a
relatively long life cycle, because engineers do not want
to rework the link between the NOR and other
components. Spansion has been very effective in taking
market share from Intel, and we believe it will be able to
keep these market gains and even extend them.
Spansion's road may be a rocky one, however. We expect
the main driver for the firm's sales will be to low- to
midmarket mobile phones. Because of the limited number
of handset makers and the vicious price competition,
Spansion isn't likely to get a break from pricing pressure.
Also, Samsung, the largest memory producer in the world,
is turning its sights to the NOR market now, after having
ignored it for some time. While Spansion's market share is
still 5 times greater, Samsung is a tough rival with
enormous manufacturing capabilities and will give
Spansion a run for its money, in our opinion.
Valuation
Our fair value estimate for Spansion is $14 per share. We
assume that the NOR market, while shrinking in dollar
value in 2007, will increase to roughly $10 billion in 2011,
driven by increased demand for mobile phones and
embedded devices in developing economies. Furthermore,
we believe that high-quality products and good customer
service will allow Spansion to continue to win market
share each year. We project that by 2012, Spansion will
hold roughly 40% of the market; Intel and
STMicroelectronics STM combined will hold roughly 25%;
and Samsung will be a strong third at 15%, with the
remainder scattered among smaller producers. These
assumptions generate a compound annual growth rate of
10%--much lower than the firm's historical growth rate of
25% per year. We believe gross and operating margins will improve from present levels as depreciation related to
heavy capital expenditures works itself off the income
statement, and research and administrative efficiencies
are realized. Under our assumptions, Spansion will not
turn profitable until 2009 on an operational level. These
assumptions generate returns on invested capital that
reach a maximum of 9% in 2012, less than our assumed
11% cost of equity. We forecast an operating loss of more
than 4% in 2008 as a result of continuing tough operating
conditions.
...
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