JP Morgan downgrades Sandisk

Citing profit warnings from Intel, Toshiba and Sony Ericsson, JP Morgan cuts Sandisk from outperform to neutral. They say this call is late.

Sandisk continues to languish

Toshiba blew up this morning -- there wasn't a lot of new information there. HD-DVD is a failure and NAND pricing remains a drag on profits. As Sandisk is Toshiba's NAND fab partner, I might as well reiterate my dislike of the shares.

The good news is their product costs are declining. The bad news is retail pricing for cards continues to deteriorate. The cell phone market is seeing incremental weakness (TXN and ERIC, for example) which will further pressure the add-in and OEM card market.

I remain negative on Sandisk and the semicaps levered to memory such as KLAC, LRCX, MTSN and VSEA.

Intel (INTC) lowers 1Q:2008 gross margin forecast

Guess what? NAND prices still suck. Intel lowers gross margin guidance due to NAND pricing. They have to be really bad to be hurting Intel that much since they're not a big chunk of business. Still hating Sandisk and memory capex plays here.

Sandisk meets with analysts, releases 10K

There's an analyst meeting going on right now. They say business so far this quarter is about as they forecast – lousy.

Sandisk files their 10K. There's some elaboration on the off-balance sheet aspects of their joint ventures with Toshiba to produce NAND flash. The basic gist of it is they own 49.9% (just not enough to not have to include the operations in consolidated results) of the JVs. They're on the hook for 50% of the output. If they incorrectly forecast demand they get stuck with a lot of raw NAND at cost plus a mark-up. They don't really get into how much of a liability that can be but the ventures have been ramping capacity at a significant pace.

There's some currency double-talk. They say they don't really hedge but then say they've got a 500mm+ position short the dollar. They also say they're buying product from Japan that's being produced in China. Confusing.

They intend to spend $4 billion on further off-balance sheet fab equipment over the next 3 years and will likely have to sell debt to raise the cash. That's a very big number, 4 billion. On February 19^th, 2008, Toshiba and Sandisk signed a memorandum of understanding to begin a new 300mm fabrication facility in 2010 – presumably this will involve more spending when the time comes. The potential for debt issuance is not a new issue as analysts have discussed it but it's one thing when business is ripping and the company says things are so good they need to invest further in the business. It's quite another thing when business looks weak.

Why do they continually structure the JV to hide the real P&L of the business? I think it's a multi-billion dollar blind spot in the story and I don't like it.

Sandisk cost accounting seems good... for them

I thought this was worth reprinting:

The resulting price falls halved Toshiba's operating margin in its chip business to 4.8 percent in October-December from 10 percent in the previous quarter, and cut the unit's profit by 60 percent.

Toshiba has a lot more moving parts but they're saying the margin degradation came primarily from NAND flash.

So Sandisk is injecting vast amounts of working capital into an off balance sheet JV (Flashvision, which they co-own with Toshiba) that's hurting Toshiba's results substantially and yet Sandisk reports pretty healthy product gross margins and profits.

I just don't think Sandisk's financial statements give a clear picture of the health of the company. They don't tell you what their real manufacturing costs are. I think it's a deceptive structure.

Sandisk Q1:2008 Guidance

Wow, that's pretty terrible. They guide to 775-875mm for Q1, street is ~1 bil. There's that 150mm miss I was talking about. They guide the full year to 15-25% growth, street is at 23%. Numbers will come down pretty hard. I'll have some more summary tomorrow AM.

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.