There’s a long way to go in the Samsung hostile battle to gain control of SanDisk, and a virtual intellectual property and market share monopoly of Flash memory chips. The rivals each have a chance to make their play and in our view, all counter bids by rivals will have the blessing of the competition authorities around the world, and the Justice Department ‘ and although no-one has mentioned this aspect of the deal yet, we don’t think Samsung will get the same blessing.
This is because the entire ownership of the Flash memory industry is a stake here ‘ Samsung is already dominant in terms of chips shifted, and despite a huge increase in requirement, it is Samsung that has artificially brought about the parlous share value around stocks like SanDisk, pumping more and more resource at Flash memory capacity, knowing that the resulting price falls will crash the performance and share price of others in the market.
And cleverly this is not Samsung going after a direct manufacturing rival with its own chip capacity, this is an indirect attack on the market chasing the depressed share price of the dominant US force, which only has the largest Flash memory retail footprint, and which has also carved out a leadership position in patents relating to onboard Flash controllers ‘ something of a thorn in Samsung’s side, given that it is a net payer of royalties in the direction of SanDisk, and which brings $500 million into the company each year at present, and it is likely that a considerable amount of that figure comes from Samsung.
During the past two years the two companies have had a continuing legal battle over patents, with SanDisk stating that it doesn’t need and won’t pay for any more Samsung patents. Meanwhile the most recent filings show that Samsung makes up around 13% of SanDisk’s $3.3 billion in revenues, some $400 million on an annualized basis. The two are currently in negotiations to renew the Samsung licensing deal.
In our view, allowing Samsung off the hook in terms of royalties and then giving Samsung the royalty whip hand in the global Flash market (the only other significant holder of patents in Flash controllers is Lexar, now owned by Micron) would invite a monopoly position for Korea, and it would happen simply because of two things, the US financial markets are in turmoil and the Flash memory market is suffering oversupply, largely created by the ‘fight to the death’ pricing and commitment in this market of Korea’s Samsung. The value to Samsung of this deal would be well in excess of $10 billion in future market control and revenues ‘ so we agree with the SanDisk management that this $5.9 billion deal vastly under values it, despite its current $3.4 billion market capitalization, especially given that two years ago that was its precise market capitalization, three times what it is today.
The potential White Knights in this deal are the same companies battered by the constant price revisions and manufacturing muscle of Samsung ‘ Korea’s Hynix, IM Flash Technologies; the joint venture between Intel and Micron, and of course the SanDisk manufacturing partner Japan’s Toshiba.
Even Numonyx, the recently formed joint venture between Intel and ST Micro’s NOR Flash divisions said in August it is working with Hynix to chase a decent market share in NAND flash, but we doubt very much any kind of white Knight could come from there.
The most likely counter bid is some form of closer knit ties between Toshiba and SanDisk, or something similar bringing SanDisk closer to the other US Flash companies at IM Flash Technologies. Perhaps it might merge with Micron and have some form of cash injection by Intel. If Intel lets Samsung continue its rampaging form in the Flash market it can kiss goodbye to any claims that it remains the largest chip company in the world.
But it will take some considerable commitment for any such counter bid to be made to look both credible and palatable to shareholders, and we suspect that simply brazening out the hostile bid, combined with playing up the potential regulatory blocks, would be a better route. Intel and Toshiba might object with the Korean, Japanese, US and even European authorities that such a tie up would prejudice Flash pricing in those territories through monopoly control, and they’d be right.
From the point of view of shareholders of the SanDisk stock, this kind of seesaw ride in Flash memory is neither permanent nor unprecedented and a strategic shift towards stronger royalties would move it further from market pricing dependence, so it might direct management in that direction. Whatever happens the market oversupply of Flash is not going to go away.
We know that Samsung this year committed to growing Flash factory capacity, including a new US based plant, while Toshiba almost trebled capacity trying to catch the Samsung market lead. Given that Samsung holds over 40% of the Flash market and Toshiba around 28%, the two between them account for dominance in Nand Flash production, and Hynix has just announced another factory in Cheongju about to add another 40,000 Flash wafers a month using 40nm technology.
Samsung is driving this market on a ‘last man standing’ basis, and although pricing per megabyte fell some 36% during the past quarter the entire handset industry can suck up all the Nand memory that these giants can build, and if the pricing goes much lower, these chips will simply invade laptops to replace rotating storage, and rise in volumes in cameras, TV sets, set tops and mass storage devices (such as IPTV VoD servers) and DVRs in the home. Given that Flash is beginning to invade the turf of hard drives, Seagate, itself only currently valued at $5.9 billion, having also suffered a 2 year price decline that has seen its value more than half, and Western Digital, which has seen its share price do well of late, may consider that it is time to take out a major insurance policy against the death of disk drives, and help support a bid, perhaps working with Intel and Micron, to keep SanDisk from Korean ownership.
In the end the Investment banks which would usually be working overtime on a series of creative possibilities to secure SanDisk’s future, are too busy counting their pinks slips or applying creativity to ensure their own survival, and Samsung might only be prevented from another step in the direction of global chip dominance by the risky strategy of reliance on the regulatory framework to see this deal slowed down or stopped. Such a reliance might prove entirely too risky to the entire high tech segment so expect someone else to make a move, and soon.