Companies that report their results ahead of schedule usually do better than the forecasts. Indeed, two thirds of the companies that have published their reports have outperformed the analysts’ forecasts. Among the Israeli companies, the first three to publish their reports Mercury Interactive Corporation (Nasdaq: MERQ), RADVision (Nasdaq: RVSN), and M-Systems Flash Disk Pioneers (Nasdaq: FLSH) more than delivered the goods, reporting very good results. I’ll concentrate on M-Systems, because I think it’s the best show in town.
M-Systems is growing at 75% per year, and 15% per quarter. The company has invented a totally new product and market the DiskOnKey (DOK). DOK sales have grown 50-fold, from $300,000 in the first quarter of 2001 to $16 million in the second quarter of 2003. M-Systems’ Mobile DiskOnChip (MDOC) has been included in the cellular telephones of four out of the five largest manufacturers: Nokia (NYSE: NOK), Samsung, Ericsson (Nasdaq: ERICY), and Motorola (NYSE: MOT). The names are from a CIBC Oppenheimer report, which M-Systems has not confirmed. As if that weren’t enough, the company announced in its most recent conference call that it was entering the memory card market, which amounted of hundreds of millions of dollars a year, was developing new DOK derivatives, and had plans for new products, about which little was yet known.
M-Systems founder, president, and CEO Dov Moran, who has undoubtedly been affected by the Japanese with whom he has dealt with for over a decade, does not look one quarter ahead, as the Americans like to do. He looks many years into the future. He’s managing the company like a four-man, 400-meter relay team, with the baton being passed from product to product, towards the final goal of becoming a giant company ($1 billion in sales, as he said in the summer of 2000), and a profitable one, with a wide variety of unique flash technology-based products. The DOK is now passing the baton to the MDOC, which will give way in another two years to the memory card, which will pass the baton four years after that to a product whose nature Moran knows, but will not disclose. The only difference between M-Systems and a relay team is that products do not withdraw from the race after they pass the baton. The DOK will grow for many years, together with the MDOC, which is just getting underway, as the DOK did before it. MDOC sales are almost doubling each quarter, and it will continue for many years after the memory card gathers up a full head of steam.
Some of the analysts, and especially frustrated investors, are unable to stand the pace M-Systems is setting. These investors have been running beside the company for many years, waiting for the glorious day when it will make a profit. Every time the company approaches that point, a new product appears that demands new investment, and the profit goal again moves into the distance. The frustration is all the greater, when two other NAND memory cards companies, SanDisk Corporation (Nasdaq: SNDK) and Lexar Media (Nasdaq: LEXR), are growing rapidly and making a profit, and their share price has jumped 10-20% since they published their results last week, while the M-Systems share fell.
You can get an idea of the investors’ frustration from the chat sites immediately after the company results are published, or you can read UBS Warburg head of Israel office Stephen Levey, who has already raised his target price for the share three times, but tells investors not to buy the share, because the company isn’t making profit, and is fully priced. Almost in despair, he asked during the conference call, “What are you doing with the $2.5 million expected added sales next quarter?”
I suggest that all those people frustrated by the company should regard it as if it had been founded in early 2001, when the DOK and MDOC were launched, and forget about the years before that. Passing the break-even point by the end of the current year, or even in the third quarter, as I predict, will then seem natural and reasonable, and perhaps even surprising, in view of the company’s many investments and activities.
Before 2001, M-Systems focused on the market then considered the hottest: Internet access devices and set-top boxes (STBs- digital cable converters). Company sales peaked at over $90 million in 2000. SanDisk and Lexar were left in a market that appeared saturated at the time memory cards for digital cameras. Almost all these two companies’ prosperity is now in this market, because consumers are buying cards with ever-increasing capacities, and the number of cameras is also spurting. All of those who said the market was saturated were wrong. M-Systems’ customers were telecommunications equipment companies, and their customers were telephone and cable companies, most of which have gone out of business, or are suffering from the crash. In the digital camera market, the customers are either consumers, who, as everyone knows, are bearing the US economy on their shoulders, or Japanese camera manufacturers selling to those consumers.
Yesterday, for example, my “Globes” colleague Shlomo Greenberg wrote about the meteoric rise of Scientific Atlanta (NYSE: SFA), which manufactures cable converters. As he wrote, the share’s rise can be attributed in full to huge orders by one customer New York company Cablevision Systems (NYSE: CVC). These massive orders were transferred from Sony (NYSE: SNE) to Scientific Atlanta. Sony’s converter included M-Systems’ DiskOnChip (DOC). Had Moran focused on this market, he would now have to explain why Cablevision was abandoning Sony, thereby costing him a major customer, and why the DOC was not included in Scientific Atlanta’s converter. He wasn’t asked this question in the recent conference call, because M-Systems is focusing on the DOK and the MDOC. Although DOC sales still amount to millions per quarter, they have stopped growing.
M-Systems’ successful penetration of the wireless devices market is the most dramatic development in the company since it was founded. In the long term, it will compensate the company for the loss of the digital camera market not only because of the market’s size, but because M-Systems will enter the digital camera market through the back door, when the two products are merged into one. About a month ago, the “Yediot Ahronot” Hebrew daily interviewed the number-two person in the Samsung telephone division, who was on a short visit to Israel. He said that in two years, all Samsung’s telephones would incorporate cameras.
CIBC Oppenheimer says that M-Systems’ chip is being included in Samsung devices. That seems logical to me, after these companies published an official announcement a month ago, saying that the DOC had been installed in Samsung’s converter, which would be marketed to Yahoo! BB, Japan’s largest Internet provider.
As part of a survey of Israeli shares, Merrill Lynch analyst Ilana Treston wrote a year ago that Merrill Lynch would not recommend the share until M-Systems proved it had penetrated the wireless market. The NetScreen Technologies (Nasdaq: NSCN) CEO has publicly stated that he had gained “an Israeli airline” as a customer, at the expense of his company’s great competitor, Check Point (Nasdaq: CHKP). Were Moran to adopt this public relations style, he would issue a bombastic announcement, headed “We’ve replaced Intel (Nasdsaq: INTC) in some cellular devices,” and Merrill Lynch and the others wouldn’t wait long before recommending M-Systems.
Before conquering its huge market, M-Systems faces a difficult problem. There is a shortage of NAND flash chips, the company’s raw material, in the current quarter, and it may persist. SanDisk made an announcement to this effect when it published its results, giving its forecasts for the rest of the year. This is a problem for everyone, including SanDisk, although it has a joint production line with Toshiba. When you’ve got sales of $1 billion per year, however, as SanDisk will have in 2004, and which is also Moran’s goal, you must constantly increase your supply and production capacities. That’s also the reason why SanDisk announced a $500 million share issue, the proceeds from which will be invested in the production lines it jointly runs with Toshiba in Japan.
In the conference call, Moran also announced that he was acting to guarantee “supplies and prices” of the chips. It will be interesting to see how he solves this problem, because in this market, everyone competes with everyone else, and everyone supplies everyone else. While M-Systems may later want access to supplies from the joint Toshiba-SanDisk flash chip production lines in Japan, Moran has announced his company’s entry in the memory card market, in direct competition with SanDisk. He could join up with giant European chip company STMicroelectronics (NYSE: STM), but M-Systems’ entry into the memory card market also threatens this company. In addition to Toshiba, Samsung is already an M-Systems supplier, but Samsung is threatening to compete against M-Systems with its own version of the MDOC. What all these competitors/suppliers have in common is that they lack the advanced patented DOK technology. That may be the coin that Moran can use to ensure regular supplies at guaranteed prices.
Published by Globes [online] -l www.globes.co.il - on July 22, 2003