-Contact Thomas Rasmussen
When SanDisk released its dismal earnings this week, dismayed shareholders hastily headed for the hills. The exodus caused SanDisk’s stock to plunge 25%. In the fourth quarter of 2008, the flash memory giant lost $1.6bn, pushing its total loss for the year to $2bn. This red ink from operations was exacerbated by the company’s $1bn of acquisition-related write-downs stemming from its $1.5bn acquisition of msystems in July 2006. In the days following the dire news, SanDisk has been trading at a valuation of around $2.2bn. That’s a far cry from the $5.6bn that Samsung offered for SanDisk in September.
To put the decline in perspective, SanDisk’s three largest outside shareholders – Clearbridge Advisors, Capital International Asset Management and Capital Guardian Trust, which collectively own more than 15% of SanDisk (as of September 30) – suffered a paper loss of more than $700m since the day Samsung walked away from the proposed deal. Given this, we wouldn’t be surprised if shareholder ire forced SanDisk to reconsider its strategic options this year. On its earnings call this past Monday, the company reiterated that its board is indeed open to deal with any interested parties, which begs the inevitable question: Who might be willing buyers?
With private equity largely stymied and longtime partner Toshiba repeatedly stating that it’s not interested in a deal, Samsung is still the most logical fit. It has the cash, has shown a willingness to pay a solid premium, and would integrate well with SanDisk’s overall portfolio of products. In addition to its valuable intellectual property assets (which would eliminate those ugly royalty fees) and flash and solid-state drive lineup, SanDisk would instantly give Samsung the second-largest share of the music player market, behind only Apple. Perhaps it’s time for SanDisk CEO Eli Harari to brush up on his Korean, or at least learn how to say ‘please come back’ in that language.
Napster, once hailed as the king of digital music, has fallen on hard times. Its stock is down 35% this year alone, and 55% from its 52-week high set in October 2007. Resulting shareholder ire forced the company to announce last week that it is seeking strategic alternatives to boost value, and it has hired UBS Investment Bank to lead the effort. Who might acquire the house that Shawn Fanning built?
Since relaunching as a legal music service in late 2003, Napster has been unable to turn a profit. The company pulled in $125m in revenue for the trailing 12 months ended June 30 from about 708,000 paid subscribers. Despite increasing revenue 15% year-over-year, the company had a negative EBITDA of $12.3m and subscriber count decreased from last quarter’s total of 761,000. The switch from stagnation to a drop in subscribers for the first time means that Napster will be unable to keep growing revenue. Consequently, that makes it doubtful that it will be able to achieve profitability. Nevertheless, with $36.9m in cash and $30.7m in short-term investments, Napster is an attractive target at its current valuation of $62.25m.
We previously speculated that SanDisk would attempt to acquire a proprietary music service of its own. But given its financial woes, as well as reported takeover negotiations with Samsung, we do not think it will bite. We believe Napster’s fierce competitor RealNetworks, the majority owner of the Rhapsody music service, is the most likely acquirer. Amid growing competition from Apple, which unveiled its iTunes 8 and a new line of iPods this week, and with digital music newcomers Amazon, Nokia and a few promising startups making waves, this is a much more plausible proposition. Last year Rhapsody picked up Viacom’s Urge, which had been struggling despite its high-profile association with MTV and Microsoft. RealNetworks has the cash, and has repeatedly told us it is bullish on acquisitions that spur growth. Given Napster’s current valuation and similar deals, we estimate that it will fetch around $80-100m in a sale.