Ah, the Street -- always quick with the decision, even if it's short on the details.
Today, I'm taking a look at SanDisk (NASDAQ:SNDK), which is being hammered after an announcement from Apple (NASDAQ:AAPL) that details long-term relationships with several Flash memory providers. These include Samsung, which already provides the bulk of the flash for Apple's iPods that use it, along with Hynix Semiconductor and Toshiba, which is already SanDisk's partner in a joint venture to produce low-cost raw flash memory.
Enter Intel
But what's sending investors running for the hills is the final supplier, a just-announced joint venture between MicronTechnologies (NYSE:MU) and Intel (NASDAQ:INTC). To be sure, it's never a great thing to see one of the chip industry's behemoths come stepping into your turf, let alone a pair of them. But the reaction today is based more on fear than knowledge.
Let's be clear: How this all unfolds in the long run isn't certain. But first things first. The pundits out there who are saying it's "bad news" that SanDisk didn't get a piece of this action (and I actually did hear this last week on CNBC, after the news of the first Apple-Samsung deal) don't know much about SanDisk. SanDisk has never counted Apple among its customers, for a simple reason: It doesn't supply raw flash to device makers.
Indeed, the commodity end of the flash biz -- hawking raw flash memory -- is precisely the minefield that SanDisk has tried resolutely to avoid. Its successes have come from its end-to-end integrated production model (part captured raw capacity, part open market), its low-cost MLC NAND flash technology, and, more importantly, by creating markets through introducing new standards, technology, and form factors. In other words, efficiency, pricing power, and digging moats where they can be dug.
The real problem
The reasonable bear argument is that all this capacity coming online could flood the market with flash ram, forcing a related drop in prices on end products like memory cards and stick drives, to the point where SanDisk will see a negative return from its joint ventures with Toshiba. While that can happen (and has happened for periods in the past), as for SanDisk's death knell, it's more than a bit ahead of its time -- for several reasons.
The flash landscape
First, Toshiba and SanDisk are the leaders in the low-cost MLC flash that's flowing to increasing numbers of consumer devices.
Next, the market for flash is expanding so quickly that there's still a major lack of capacity. SanDisk has said it doesn't even compete in certain markets because it hasn't had the capacity to move products there. In fact, to go back to the beginning of this story, the lack of capacity is the entire reason that Apple has struck these deals. (Remember, the new Intel joint promises the lion's share to Apple.)
Since Apple has already proven to be a tough negotiator on the prices it will pay, in order to make these deals work, many of these flash suppliers will likely need to turn to the lower-cost MLC technology that SanDisk licenses, or ramp up their production of MLC, if they're already making it. All of that would mean a bigger royalty stream to SanDisk.
The royalty stream
Whether or not the new Intel/Micron joint venture will be in the same position is the subject of more than a little confusion in the news today. Though the press release touts Intel's expertise in MLC technology, it's primarily related to NOR flash (not the kind we're talking about today). That expertise can be transferred to NAND flash -- as SanDisk did -- but not immediately. There are claims that Intel and Micron wouldn't have to pay SanDisk any MLC royalties. Not entirely accurate, at least from SanDisk's point of view. In a conversation with SanDisk CEO Eli Harari, he explained that although Intel and SanDisk have a cross licensing agreement that may exempt that chunk of the partnership from MLC licensing fees, SanDisk says it expects the Micron half will have to pay its part. That may be a moot point in the beginning because, according to other reports, the joint venture will start its NAND production with the more expensive SLC technology.
Flash of the future
With iPod -- and, I bet, iPod-ish devices yet to come -- gobbling up such an enormous portion of flash capacity, it will, very possibly, leave less raw memory out there for the rest of the world to fold into competing flash products. In fact, the slowdown in flash price drops has already been observed in the post iPod NAND market.
Finally, NAND flash of all types is moving into ever more products. Cell phones, for example, have been a major growth engine for SanDisk, which came up with the TransFlash removable flash storage standard that's in an increasing number of phones. Moreover, you may soon see flash in every PC sold. The next generation of Microsoft's (NASDAQ:MSFT) Windows with Intel laptop architecture is being designed to take advantage of flash ram to cut computer startup time drastically, and possibly improve battery life in portables.
In fact, I believe this is the prime reason Intel is getting involved in NAND flash at this point. I think the odds are good that a sizable portion of what's left over from Intel's Apple deal will be funneled toward the computer makers for this use. Harari took a similar point of view today, telling me that the Intel move would "very likely accelerate adaptation of NAND flash in computing, which is very good for all of us."
Foolish bottom line
Sure, there's the chance that flash ram demand may suddenly drop, or -- more likely -- not increase by the same degree as oncoming capacity. That, in turn, could flood the market with cheap raw flash, pushing down prices on end products and pinching SanDisk's margins. But there's no sign of that for some time to come. (And remember, last year at this time, a very large number of the Experts were saying we'd be seeing big glut right now, and exactly the opposite is true.)
That's why, in my opinion, the real losers today are the mini-hard drive manufacturers like Maxtor (NYSE:MXO), which recently ditched gear for making its teeny-weeny drives. It's clear today -- as it's been clear to me for quite a while -- that their ride on the iPod wave is coming to an end.
As for SanDisk, take a deep breath and keep your eyes on the numbers. Yes, it needs to stay on top of its game, but it's been competing in a pretty cutthroat field for quite some time. Samsung, Hynix, and the rest are just as tough as Intel. My Foolish point of view on this is opposite Mr. Street's: This news flash looks like good news for everyone in the flash business, SanDisk included.
For related Foolishness:
- Maxtor steps away from the iPod buffet.
- The right fears usually come at the wrong time.
- It's easy to see why NAND flash dazzles investors.
Seth Jayson finds the whole flash biz a bit tough to stay on top of from time to time. At the time of publication, he had shares of Microsoft and SanDisk, as well as covered calls, but had no position in any other firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.
