M-Systems latest moves look good

CEO Dov Moran: Well exploit the wireless opportunity.

Ostensibly, on the basis of its share price, nothing happened at M-Systems Flash Disk Pioneers Ltd. (Nasdaq:FLSH) yesterday. The share rose 0.1% on half its daily average trading volume. But the company did make an important strategic announcement with several aspects, the most important of which was the acquisition of Microelectronica Espanola for $40 million in cash, which will enhance M-Systems mobile product portfolio and broaden its channel access to the mobile market.

Analysts reports published over the last couple of days tracking M-Systems latest moves sound especially optimistic. M-Systesm president and CEO Dov Moran also takes an optimistic tone in conference calls.

M-Systems develops and sells Flash memory processors for a range of applications, including mobile devices, computer memory, and mobile memory through the companys DiskOnKey product. The announcement of the acquisition of Microelectronica Espanola is expected to give M-Systems access to the mobile market. Microelectronica Espanola makes SIM and smart cards, and had 1% market share in 2004. The company has relations with handset manufacturers and wireless operators, through which M-Systems will be able to sell its MegaSIM product for boosting the storage memory of current SIM cards. MegaSIM will be launched next year.

M-Systems paid a gross $75 million for Microelectronica Espanola, and a net $40 million. The difference is due to Microelectronica Espanolas $27 million in working capital and the rest is for inventory and customers. The deal was signed and closed on the same day, Monday. The acquisition will have no effect on M-Systems bottom line for 2006.

At a conference call on Monday, M-Systems said revenue from Microelectronica Espanola would be 25 million in 2005 ($29.3 million), but because there are only six weeks left in the year, the contribution will not be substantial. During the conference call, M-Systems CFO Ronit Maor said Microelectronica Espanolas gross profit margin was higher than M-Systems. The company has 140 employees, most of whom will join M-Systems.

Moran said at the conference call, Analysts believe that one billion mobile devices will be sold globally in three years, most of which will have multimedia capability. We intend to exploit this opportunity by offering a range of storage solutions for the wireless market. We dont expect immediate results in the short term. In the long term, we have no doubt that the effect of the acquisition of Microelectronica Espanola on M-Systems will be immense, and in a few years will become very substantial, possibly even generate most of our revenue.

M-Systems SVP strategy and M&A Arnon Dinur said during the conference call, We had three goals with this acquisition. The first is to have our own technology for secure smart cards. The second is to have an approved manufacturing infrastructure for smart cards. The third is direct access rights to wireless operators. We believe that weve achieved these three goals.

WR Hambrecht and Co. analysts Daniel Amir and Lena Zhang predict that Microelectronica Espanola will contribute $33 million to M-Systems revenue in 2006. We still like the M-Systems story because it continues to demonstrate strong performance. There are very few semiconductor companies able to show 36.5% growth in revenue and 34% growth in profit for 2006.

Oscar Gruss Israel senior analyst Rami Rosen says, We expect no impact over fourth quarter of 2005 results (aside from a one-time in process R&D amortization of $3 million). We expect a goodwill amortization of around $3.4 million during the 2006 fiscal year.

Citigroup analyst Craig Ellis is pleased by M-Systems direction, and states that Microelectronica Espanola will contribute $4 million to M-Systems revenue for the fourth quarter. Although he did not change his forecast for M-Systems revenue for 2005, he raised his revenue forecasts for 2006 and 2007. On no change in multiples, our target price increases to $38 from $35, and while M-Systems offers approximately 19% estimated total return (ETR), this is simply insufficient to warrant a Buy rating.

M-Systems has a market cap of $1.1 billion.

Published by Globes [online], Israel business news - www.globes.co.il - on November 16, 2005

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