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No. of Recommendations: 2
Some more thoughts on SanDisk

Dilution
• November 19, 2006, closed acquisition of msystems, an Israeli-based semiconductor company with a broad embedded NAND product portfolio, deep firmware expertise, and extensive OEM relationships. SanDisk issued approximately 29 million shares
• On January 13, 2006, we completed the acquisition of Matrix Semiconductor, Inc. Issued 3,722,591 shares
EOY       2007       2006       2005        2004      2003
Basic 227,744 198,929 183,008 164,065 144,781
Diluted 235,857 207,451 193,016 188,837 171,616
So net of those two purchases from 2004 to 2007 basic shares increased at a CAGR of 5.9%, while diluted increased 2.4%.

http://www.sandisk.com/Corporate/PressRoom/PressReleases/PressRelease.aspx?ID=4088
SanDisk repurchased 7.5 million shares during 2007 under a previously announced $300 million share repurchase plan to reduce the level of stockholder dilution caused by issuance of employee equity incentive awards.
These shares purchases look like an extremely poor investment at this stage, with much of the repurchases done at over $40. I also intensely dislike ESOs and using shareholders funds to reduce the effect on dilution is not a good use of funds. SanDisk appear overly generous with their options.

Without digging deeper a 5% dilution would appear to be appropriate. For young tech companies I generally use 5% and for more mature tech companies 3%.

ROE
Using the three year average is an excellent idea. Now I have to figure out an easy way of getting that. S&P reports have ROE for past ten years, but they seem slow to update the data, as for SNDK they still don’t have the 2007 data.
EOY       2006    2005    2004    2003
ROE(%) 5.46 12.73 11.92 8.36
As for backing out cash to derive at adjusted ROE, I need to think about that some more. My initial view is that management have chosen to hold cash for some reason and as there is a risk of them wasting this cash they shouldn’t receive any benefit (adjusted ROE) for holding cash. Conversely, earning should probably be adjusted down by interest received, to adjust for risk of management wasting the cash.

http://ogres-crypt.com/php/advfn-financials.php?sym=SNDK&per=a provides normalised ROE, which is different from S&P.

Maybe as a short cut I could use Reuters as they provide TTM and a five year average ROE of 4.49 and 9.15 respectively. http://stocks.us.reuters.com/stocks/ratios.asp?rpc=66&symbol=SNDK

Falling ASP
“from 2005 to 2006, we increased the number of megabytes sold by 221% in large measure due to a decrease of 58% in our average selling price per megabyte over the same period”
That comment is the nub of SanDisk and similar percentages can be found in all their annual reports. I ignore the falling ASP and focus on the revenue and gross margins, see below.

Earnings Multiples
assuming earnings multiple stays at 16x (maybe it will, maybe it won't)
I work under the assumption of it won’t. The short term fluctuations in share prices are best explained by investor sentiment and have little to do with earnings. In recent years the SNDK share price has fluctuated around 50% a quarter and over 100% annually. For example the average quarterly fluctuation in 2006 was 50% with a yearly fluctuation of 114%. Despite the large drop in share price in Q4 of 2007, prices were more stable in 2007 with a 36% quarterly fluctuation and 80% yearly fluctuation.

One of the big questions I ask prior to an investment is where do I think the share price is now within its likely range for the next quarter and year. For a quick look at this I use Big Charts and BMW charts and if I want a more accurate view I use a spreadsheet which Bakuvdanet wrote. All of those strongly suggest to me that SNDK is much closer to the bottom of its trading range for the next quarter and this year. While in stable large industrials the weighing machine and a long term view are appropriate I have found that in technological it is as, if not, more important to focus on the voting machine.

Margins
                       2007     2006     2005     2004  
Product gross margins 21.8% 31.0% 35.5% 31.9%
Total gross margins 30.9% 38.0% 42.2% 38.6%
At first look gross margins have fallen significantly in 2007. However, a quarterly view shows a different story. GMs took a massive hit in Q1 and have been improving since. The Q1 hit was primarily due to falling ASP that were not offset by lowered cost of production. With restructuring and the implementation of 56-nanometer they have turned this around. They are now transitioning to 43-nanometer technology.
This constant need to upgrade is one of the big down sides of investing in semi companies and another reason why I am always quick to sell as in the long term I think they consume to much capital for the returns they will provide.

Other Stuff
Maybe later, other things to do now.

Reference:
• 2006 Annual Report http://yahoo.brand.edgar-online.com/fetchFilingFrameset.aspx?dcn=0000891618-07-000116&Type=HTML
• 2005 Annual Report http://yahoo.brand.edgar-online.com/fetchFilingFrameset.aspx?FilingID=4278938&Type=HTML
• 8K on purchase of msystems http://yahoo.brand.edgar-online.com/fetchFilingFrameset.aspx?FilingID=4787377&Type=HTML
• 8K on purchase of Matrix http://yahoo.brand.edgar-online.com/fetchFilingFrameset.aspx?FilingID=4140600&Type=HTML
• Article on purchase of Matrix http://www.internetnews.com/bus-news/article.php/3558381
• 2007 Annual Report http://yahoo.brand.edgar-online.com/fetchFilingFrameset.aspx?dcn=0000950134-08-003259&Type=HTML
• Q4 2007 Conference Call http://seekingalpha.com/article/62011-sandisk-q4-2007-earnings-call-transcript?page=-1
• Good presentation http://library.corporate-ir.net/library/86/864/86495/items/260250/Citi_Presentation_090507.pdf
• ASP and Mbs http://media.corporate-ir.net/media_files/irol/86/86495/QtrlyMetricsforweb.pdf

Any thoughts are of course most welcome.

Cheers
Dean
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