Possible Scenarios In The SSD Space That Could Significantly Move SanDisk’s Stock Price

-6.15%
Downside
76.18
Market
71.49
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SNDK: SanDisk logo
SNDK
SanDisk

SanDisk Corporation (NASDAQ:SNDK) is one of the leading flash storage providers in the world, deriving most of its value from the sale of solid state drive (SSDs). According to our estimates, enterprise-grade and client SSDs combined make up about a third of our $74 price estimate for SanDisk. Our price estimate implies a 10% premium to the current market price, which plummeted by nearly 20% in late March, when the company revised its revenue guidance for the first quarter. The company reported a 12% year-over-year decline in net revenues in Q1 to $1.33 billion while its gross margin (non-GAAP) for the quarter was over 8 percentage points lower than the comparable prior year quarter at 43%. [1]

Much of the decline was attributable to product qualification delays that impacted embedded storage and enterprise SSD sales, coupled with lower-than-anticipated demand in the enterprise storage market due to shifting market trends. To add to an unimpressive Q1, SanDisk might continue to have a tough year in terms of client SSD sales, mainly as it lost a major customer in January. It is widely believed that the customer was Apple (NASDAQ:AAPL), which has switched to Samsung (PINK:SSNLF) for sourcing SSDs. [2] [3] As a result of these developments over the last few months, SanDisk has a conservative outlook for the coming quarters. The company expects Q2 revenues to be around $1.2 billion, which is over 25% lower than the prior year quarter, primarily due to low client SSD sales through the quarter. Furthermore, the company expects full year revenues to be around $5.4-5.7 billion, which would be a 14-18% annual decline. As a result of low SSD sales, gross margins are also likely to be adversely impacted. The company expects Q2 gross margins to be as low as 37-40%. Below we take a look at some scenarios pertaining to SanDisk’s SSD division that could trigger a movement in its stock price.

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See our complete analysis of SanDisk here

Client SSD Market Adversely Affected (-10% Price Impact)

SanDisk’s SSD division has witnessed significant growth over the past few years, with revenues growing from under $40 million in 2010 to $1.9 billion in 2014. As a result, the contribution of SSDs to SanDisk’s net revenues jumped from less than 1% in 2011 to almost 30% in 2014. Within the SSD division, product sales of client SSDs (used in notebooks, tablets and smartphones) were up by 36% y-o-y to $1.25 billion in 2014. According to the company’s estimates in mid-2014 (as mentioned in its 2014 Investor Day presentation), the total addressable market (TAM) for SanDisk in the client SSD space was expected to rise from $6 billion in 2013 to about $8 billion by 2017. However, in light of recent developments and the possible loss of a major customer, the addressable market could shrink over the next couple of years. We currently forecast the TAM to decline and bottom out at around $5.6 billion through 2017.

SanDisk’s share of its total addressable market for client SSDs has risen from under 3% in 2011 to over 19% in 2014. We currently forecast this share to stay in the 18-19% range through the end of our forecast period. However, SanDisk could be adversely impacted by the loss of a major customer, if others follow suit. If some of SanDisk’s other clients, including major smartphone, tablet and notebook manufacturers, switch over to competing client SSD manufacturers such as SK Hynix and Samsung, it could lead to a significant loss of share for SanDisk. In this scenario we assume that the TAM declines to under $5 billion, and SanDisk’s share in the alternate TAM for client SSDs falls to under 10% through the end of our forecast period.

Although the smartphone market is a mature segment in developed countries, the number of smartphones in use is expected to increase from around 2 billion in 2014 to around 6 billion by 2020. [4] However, much of the growth in Asia and other developing economies is expected to come from lower-cost smartphone manufacturers. [5] A possible loss of major smartphone and tablet manufactures could have deeper implications for SanDisk than just lower revenues. SanDisk’s margins could suffer if the company’s addressable market shifts to cheaper low-margin smartphones sold primarily in developing markets. We currently forecast SanDisk’s adjusted company-wide margins to stabilize at just under 42% through the end of our forecast period. In our downside scenario, we assume margins to decline to under 39% by the end of the decade. If we factor in these three alternate assumptions, there’s a 10% downside to our price estimate for SanDisk.

Enterprise SSD Segment Outperforms Expectations (+10% Impact)

A key area of focus for SanDisk over the last few years has been enterprise-grade SSDs. SanDisk’s enterprise SSD revenues have risen at a tremendous pace from just $11 million in 2010 to nearly $660 million in 2014. In what has been a tough quarter for SanDisk (Q1’15), most of its revenue streams witnessed a year-over-year decline in revenues. Removable storage revenues were down by 17% y-o-y to $506 million, client SSD revenues fell by 48% y-o-y to $173 million and combined licenses, royalties, components and wafers revenues declined by 23% compared to the prior year quarter to $133 million. However, enterprise SSD revenues were up by over 105% on an annual basis to $187 million for the March quarter. Although the rise in revenues was slightly lower than the 140% annual growth observed in 2014, this domain remains the fast growing revenue stream for the company.

SanDisk acquired PCIe SSD manufacturer Fusion-io for $1.1 billion in  June 2014, which was expected to start being accretive to its earnings from mid-2015. However, SanDisk’s management is cautious about projecting revenue growth in the enterprise SSD space as the company has witnessed a reduction in demand for PCIe SSDs in favor of low-cost SATA SSDs. SanDisk has the largest presence in the PCIe SSD market, while it’s a relatively new player in the SATA SSD domain. The company intends to focus on building low-cost PCIe SSD solutions to reach a wider customer base, which could likely be achieved from 2016 onward. If the company can successfully capture the market with its broad portfolio of PCIe SSD solutions, there would be a gain in share for SanDisk. We currently forecast SanDisk’s share in the enterprise SSD market to rise from over 12% in 2014 to about 18% through the end of our forecast period. In this scenario we forecast SanDisk’s share to rise to 22% by the end of the decade.

Additionally, the company estimates that its addressable market for enterprise SSDs will increase to about $8 billion by 2017 from under $4 billion in 2013. If the company is successful in switching customer preferences to PCIe storage at a rate faster than currently expected, it would imply a larger TAM for SanDisk. In our alternate scenario, we assume that the addressable market (projected as enterprise units sold * average capacity per units in gigabytes * price per gigabyte) will increase by 3-4% through our forecast period. Combining these two assumptions, there could be a 10% upside to our price estimate for SanDisk.

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Notes:
  1. SanDisk Earnings Call Transcript Q1 2015, Seeking Alpha, April 2015 []
  2. SanDisk cuts revenue outlook, Market Watch, March 2015 []
  3. Samsung seals big SSD chip deal with Apple, Korea Times, March 2015 []
  4. 6 billion Smartphones in Use by 2020, Yahoo News, September 2014 []
  5. With Mobile Internet Ad Spending Growth of 210%, China Is The New Leader In The Industry, Daze Info, September 2014 []