Sandisk Rallies In Wake of Negative Barron’s Piece

Barron's took a day off from beating up Jim Cramer and went after Sandisk (SNDK-NASDAQ) instead. The way the stock is trading it looks like the Street knew the hatchet job was coming.

The flash memory chips at the heart of many flashy gadgets, such as Apple's iPod, have become one of the riskiest corners of the tech world at a time when investors aren't in the mood to tolerate risk.

SanDisk, a leading flash memory chip supplier, is caught up in that tumult. What many may not know is that the company's exposure to potential risk is a lot higher than it appears at first blush.

The true cost for SanDisk to make factories to produce flash chips is understated by funding sources that remain off its balance sheet. If the nature of SanDisk's joint manufacturing venture with Japanese conglomerate Toshiba were to change, SanDisk could be forced to consolidate those liabilities on its books. Barron's

The recent season of Wall Street Warriors featured a group of retail stockbrokers who were pitching Sandisk mid-year 2007 as their single best idea. They torched their clients, failing to uncover the bear case in the stock. Capacity issues were a reason to get short the stock years ago; Barron's is now throwing the balance sheet into the mix:

Patricola points out that S&P’s rating of double-B-minus on SanDisk’s $1.23 billion in debt is “below the apparent strength of the company’s balance sheet,” precisely because of the risk contained in SanDisk’s joint venture.

In its defense, SanDisk makes the case that funding its own production facilities pays off by bringing down its cost of goods even as prices continue to fall.

“Flash is a challenging market, but the key for us has been to be first in lowering product costs, and that comes from being at the bleeding edge of the technology,” says Senior Director of Investor Relations Lori Barker.

Sandisk might be one of the scariest stocks known to man; many moving parts make this one tricky to trade. But Barron’s is two years late in writing a negative piece on the company. Where were they at $55?

But now they are laying out an armageddon scenario:

The nightmare scenario is one in which Toshiba scales back its investment in the business, forcing SanDisk to consolidate the total expense of the joint venture on its financial statements.

That prospect seems remote, say analysts. The more imminent danger is that SanDisk is committed to buying chips from the joint venture as prices continue to fall in the market, in order to fund the venture.

If SanDisk’s profit on those chips erodes, it might have to take on more debt to keep funding the joint venture.

It’s possible the flash memory market could actually improve in the second half of this year, as manufacturing of holiday gadgets picks up, and as many flash makers reduce production, burning off excess supply.But as Goldman Sachs chip analyst James Covello points out in a recent note, SanDisk’s joint venture is “likely exacerbating the current excess supply” of flash chips.

In other words, SanDisk’s aggressive gamble is itself part of the problem of flash pricing.

At a time when the market is broadly moving away from risk, investors may want to steer clear of a stock whose capital requirements are much larger than they appear, and look to get larger still.

I certainly have no wish to enter this battleground; traders on the BuySide were likely anticipating this story, based on today’s action. Barron’s can’t make phone calls without every two-bit day trader catching wind and positioning ahead of a story. Perhaps they expected this one to be published on Saturday; will CEO Eli Harari come out and counterpunch?

Still, this is a piece that is about 30 points too late to do me any good. Making sense of this stock in the short term is best left to lunatics and drunkards.

Is SanDisk All Flash?
Barron’s
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