Company Focus
Flashy growth for memory-chip makers
Interest in cutting-edge gadgets like MP3 players and digital cameras has
exploded demand for flash-memory technology. Three companies that benefit: SanDisk, Silicon
Storage Technology and M-Systems Flash Disk Pioneers.
By Michael Brush
If the person snapping your photo this Fourth of July weekend is hip enough, you'll be playing a
minor role in a major technology investing trend: flash memory.
Reader Alert! Company Focus will move to Mondays after the week of the July 4 holiday. Look for the next Company Focus
on July 10.
The reason? The slender card inside the camera that will retain your image is one of its biggest drivers of
demand. So are many other cutting-edge tech gadgets you may enjoy -- from MP3 digital-music players and
cell phones to Palm-like devices, DVDs and DSL modems.
Brisk sales of items like these explain why flash-memory sales rocketed by 71%
last year, making it the fastest-growing segment of the chip sector. They are also
behind the powerful demand and upward earnings revisions at three companies
that design and supply flash-memory chips: SanDisk (SNDK, news, msgs),
Silicon Storage Technology (SSTI, news, msgs) and M-Systems Flash Disk
Pioneers (FLSH, news, msgs).
All three stocks are selling down right now on concerns of weakening demand from the cell-phone market,
but the fears are overdone -- presenting a buying opportunity in these stocks, analysts say.
Two characteristics set apart flash, or nonvolatile, memory: It does not get wiped out when the power is
turned off, and it can be easily erased and reprogrammed. While the leading firms in the sector are giants like
Intel (INTC, news, msgs) and Advanced Micro Devices (AMD, news, msgs), the three companies described
here are better ways to invest in the trend because they are pure plays.
SanDisk: Twice the capacity
Demand is so strong that this Sunnyvale, Calif.-based producer of removable flash-memory storage ships
only slightly better than half the cards requested by the companies making digital cameras and MP3 players.
That's a good problem to have, notes Lauren McMahon, an analyst for Forstmann Leff Associates, which
holds shares in the company.
And it probably won't change any time soon. "The market this year will be double last year's market, and we
expect it to grow at a 50% annual rate over the next five years," says chief executive Eli Harari. That would
put flash-card sales at $10 billion in five years, up from $1.5 billion in 2000.
Cards made by SanDisk, which has 28% of that market, are popular in part because they use a technology
that allows twice the storage capacity as competing cards -- which means they are also cheaper.
About 70% of SanDisk revenue comes from flash-memory cards used in consumer electronics. Around 60%
of that is linked to digital cameras; Kodak and Nikon, for instance, are major customers of SanDisk's
CompactFlash storage card. The rest comes from sales of music players and handheld devices. The other
30% of overall sales comes from cards used in things like switches, routers and base-station equipment sold
by companies like Cisco Systems (CSCO, news, msgs) and Nortel Networks (NT, news, msgs).
While both areas are growing rapidly, some of the most exciting changes will come in consumer electronics,
Harari predicts. "The landscape will be completely different. This is a disruptive technology." He says, for
example, flash cards will replace 35mm film, audiotape and compact discs. Next, SecureDigital flash-memory
cards, to ship in earnest in a quarter or two, should pave the way for the electronic sale of music over the
Internet because they block bootleg copying and have higher capacities. Use of flash-memory cards in cell
phones will bring data-intensive features to handsets -- like voice mail, digital music and mapping. A few
years out, SanDisk products will be used to store movies.
One risk for the company is that it might lose too much business because it simply can't line up enough
capacity to meet demand. Another potential threat: Sanyo's release of a magneto-optical storage device later
this year, which could cut into demand for flash products. SanDisk shares recently traded for around $57,
way down from its March high of $169; that gives the company a market cap of about $3.7 billion on trailing
12-month revenue of $312 million.
Silicon Storage Technology: Embedded memory
While SanDisk's specialty is removable chips that store data, Silicon Storage Technology is a pure play on
the other side of the business -- embedded memory that stores code. Chips produced in this larger, if
slower-growing, end of the flash-memory market basically store software commands that tell components
inside electronic devices what to do. (The Sunnyvale, Calif.-based company also has mass data-storage
products coming on line.)
Focussing on code-storage chips does not give Silicon Storage any less exposure to the hot consumer and
wireless markets. Indeed, the company's memory chips store command code in popular products like digital
cameras, MP3 players and handheld devices. Its chips also go into cell phones, Bluetooth wireless devices
and networking gear like modems used in regular and DSL Internet access.
The strongest annual growth right now comes from consumer, networking and wireless demand (340% to
600%), overpowering PC-related growth of 130%. The company has been quickly ramping up the number of
products for the newer communications and consumer markets. It will turn out about 80 products by the end
of this year, compared to only four in the middle of 1998.
Silicon Storage has staked out its turf in the "lower density" end of the market -- meaning chips that have
anywhere from 512K to 8MB of storage capacity. This is the space being abandoned by bigger flash-memory
players like Intel and Atmel (ATML, news, msgs), which favor higher-capacity code-storage chips more
commonly used in cell phones. But that exodus is a good thing for Silicon Storage. "Most people thought
that low density equals low margins," explains chief executive Bing Yeh. "That may be true for our
competitors, but not for us."
The reason is that Silicon Storage uses a patented process known as SuperFlash, says Timothy McSweeney,
an analyst Essex Investment Management, which owns shares in the company. This process brings down
costs in part by allowing the company to use smaller die sizes. It also makes for more reliable products,
because oxide layers on the chips don't break down as much.
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Revenue growth this year should reach 200%, and Yeh expects another strong year in 2001, when
he hopes sales will reach $1 billion. The stock recently traded at $78, giving the company a market
cap of $3.2 billion on trailing 12-month revenue of $169 million. While the company's proprietary
technology and focus on the low-density end of the market should protect it from competitors,
investors have to be ware of execution risks in any company growing at this rate.
M-Systems: Hard drives on chips
As Internet access flows away from the PC towards smaller devices, hard drives can't make the
transition. They are too big, slow and expensive. What's more, they eat up too much power, and they
are not rugged enough. Instead, a new kind of drive has been developed to do the job. Essentially, it
is a flash-memory chip with software on it that makes it act like a hard drive.
If Internet appliances like set-top boxes and hand-held products ever really take off, demand for this
new ‘disk on a chip' will be even stronger than it is right now. And that will be good for M-Systems,
whose DiskOnChip product provides storage inside Internet appliances.
"It is an emerging market, but the opportunity is large," says Gary Craven, a portfolio manager who
holds shares of M-Systems in the Evergreen Small Company Growth Fund (EKAAX), up 67%
over the past 12 months. No one knows for sure, but International Data thinks Internet appliances will
grow by 81% annually to reach 64.5 million units by 2002, from 6 million in 1998.
In addition to DiskOnChip, which accounted for about 80% of the company's revenue in the first
quarter, M-Systems makes a hard drive substitute known as FastFlashDisk (FFD) used in routers
and switches. This brings in about 10% of revenue, while slower-growth legacy products used in PCs
make up the rest.
"FFD will be nice but the explosive growth will come from the Internet appliance market," says Chuck
Schouw, the president and chief executive of the U.S. division of M-Systems, which is based in
Israel. DiskOnChip can be found inside Virgin Entertainment Group's Webplayer Internet access
devices, and WebTVs made by Microsoft (MSFT, news, msgs). M-Systems may be developing
relationships with Sony, Philips and Thompson among others.
Sell-side analysts expect sales at the company to grow by about 60% a year over the next three
years. That kind of outlook has helped drive M-System shares to around $72, down from $93, giving
it a market cap of about $745 million on trailing 12-month revenue of $41 million. At these levels,
Craven says, the stock is probably fairly valued, and investors might do better to wait for an entry in
the $60 range.
The big risk
Anyone who has invested in storage stocks before knows they can run up fast on enthusiasm over
strong demand for new consumer-electronics devices, only to crash hard when a supply glut leads to
savage price-cutting. Remember the rise and fall of Seagate Technology (SEG, news, msgs) and
Western Digital (WDC, news, msgs) in 1997? If not, do yourself a favor before you plunge into flash
memory, and look at the charts. Western Digital started in 1997 around $24, zipped to $54 by
August, but ended the year around $16 despite a boom in sales of PCs.
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Naturally, given the level of demand, more flash-memory supply is on its way. But analysts say it will
fall short of meeting demand at least through part of 2001. They think it might take even longer, given
that demand comes from a rich variety of consumer and telecom applications this time, not just the
PC sector.
Perhaps the cycle will be different this time. "But in these fast-growing industries, the good times are
not perpetual," notes Craven. "At some point, supply catches up with demand." If the durable recall
of flash memory inspires you to remember this fundamental rule of economics, your portfolio should
benefit in more ways than one.
At the time of publication, Michael Brush did not own or control shares in any of the equities
mentioned in this column. |
