Sandisk Q4:2007 Preview

Ok, this is going to be a tricky one so stay with me.

Sandisk is kind of the bellwether stock for NAND flash but its intensely misunderstood by the street.

Sandisk is effectively a virtual foundry for NAND. They own their own fabs through a joint venture with Toshiba called Flashvision but the investment is held off balance sheet. I hate this about the company as it really obscures the key area of fortune for them.

Their business has a large royalty component due to intellectual property patents they license to virtually all NAND producers. This is gravy -- royalties are 100% gross margin, though I would make a case that these should be looked at against legal expenses as patent enforcement is the biggest cost component to intellectual property revenues.

So that's the background. The results they report are those of a packager. They buy raw NAND from their joint venture (and a bit from Samsung if they need more than they're producing), package it into retail cards and sell them to the channel for consumption by consumers.

What I don't like about this set-up in terms of analysis is they can kinda print anything they want in terms of "cost of goods" on raw NAND purchases from the JV.

Pricing in the channel has been lousy, but it was really in December that it collapsed. There were big rebates available towards the end of the year (like most years before).

The stock is also subject to Apple supply chain push and pull which further obscures expectations. Sandisk does not supply Apple with parts for their iPod line, but whenever Apple is accumulating parts, people drive up the price of Sandisk because the price environment improves. I think when raw NAND goes up, it actually creates a cost increase for Sandisk as they're a buyer of NAND and a seller of retail cards. So when pricing goes down, it creates the inverse situation -- a better cost environment for Sandisk.

The best of all possible worlds for Sandisk is a tight retail card environment coupled with a benign contract NAND market. What they got instead this past quarter was a strong NAND environment at the beginning of the quarter due to Apple pulling on the channel for parts, followed by a weaker contract and spot market for NAND and a soft retail environment.

To me, this spells top line miss. I think they should put up a number closer to 1.1 billion versus the 1.26 billion the street is expecting. I would expect guidance is couched with an awful lot of caution. I'm pretty nervous about putting that in print but there you go... its in print.

Technical analysis tells me the stock is a buy at $18 and a sale over $28. As I said, this is a very volatile stock and my view of their business is decidedly different from that of the street.

It's probably a short but I'd be very small if I put it on. The stock has been free-falling all quarter and to some degree expectations have to be below the printed estimates.