Apple's ( AAPL) much-ballyhooed "halo effect" is spreading to SanDisk ( SNDK).

Apple's inclusion of NAND flash in its latest music player -- the already wildly popular iPod nano -- has underscored the potential of the memory technology.

And that's helped SanDisk, the inventor of flash storage cards, the largest supplier of flash data storage card products, and the holder of several lucrative NAND flash memory patents.

SanDisk shares have hit new 52-week intraday highs for the past four days. Shares reached as high as $53.37 Wednesday before closing down 34 cents, or 0.7%, at $52. The company's stock has more than doubled in the past three months alone, with a climb of about 31% since Apple unveiled its slick nano on Sept. 7.

Shares of SanDisk were recently down 15 cents, or 0.3%, at $51.85 on news of two analysts downgrading the company based largely on valuation.

Indeed, the impressive run-up of shares means that investors who were once fighting a loud bear argument about NAND flash becoming a commoditized market are now countering charges that SanDisk is turning into a pricey stock.

"We struggled for some time on whether or not to trim our holdings," Mark Mowrey, a senior analyst with Al Frank Asset Management, recently wrote in the company's "Prudent Speculator" newsletter.

On one hand, he said, the shares are getting expensive after doubling over three months. But on the other, the shares aren't that expensive, at 27 times 2006 earnings estimates and less than 23 times estimates when excluding the more than $8 in cash and equivalents on the company's balance sheet, he said.

By comparison, rival Lexar Media ( LEXR), which hasn't posted a profit since March 2004, is trading at more than 125 times 2006 earnings of 6 cents a share. But another competitor, M-Systems Flash Disk Pioneers ( FLSH), is trading lower than SanDisk at 21 times forward earnings and is preferred by some analysts because its top- and bottom-line growth is expected to surpass SanDisk's, although it's off of a lower base.

Mowrey's conclusion: Continue holding the shares for further gains until they reach $56 -- a price target the company had nudged up to $49 just a week earlier. Either way, it's a nice profit considering the firm's Buckingham Portfolio picked up SanDisk shares for $24.29 in May.

NAND flash memory is widely used in consumer devices such as digital cameras, cell phones, USB flash drives and portable music players. It's often less expensive than the alternative NOR and able to write data more quickly.

Though Apple's nano isn't getting NAND flash from SanDisk -- it's coming from Samsung -- SanDisk still stands to gain. That's because Apple's nano is expected to corner a whopping 40% of Samsung's capacity, constricting supply and consequently preventing prices from dropping as much as expected in the entire market.

"The thinking was that instead of NAND prices continuing to plummet, folks were thinking, 'Heck, maybe they'll firm up or even rise a little bit in the quarter,' " Mowrey said in an interview.

SanDisk also stands to benefit from the success of Apple's nano in another way. Samsung is expected to ramp up its use of what's called MLC, or multilevel cell, technology to make flash chips for Apple by the fourth quarter.

That also will mean more royalty revenue for SanDisk because it holds key patents on MLC.

And royalties go straight to the company's bottom line, with a margin of 100%. SanDisk reported $61.1 million in royalty and license revenue last quarter, representing about 12% of sales.

Meanwhile, SanDisk's expense line has been taking a hit in recent quarters as a result of a new fab the company has been building with partner Toshiba.

But the fab expects to be operating at greater capacities in the fourth quarter, according to SanDisk spokesman Mike Wong. That means an end to costly capital expenditures eating into earnings and a better cost structure overall, as SanDisk produces more chips itself rather than buying them from Samsung.

To date, SanDisk has been benefiting from more than 30% growth in the NAND flash market driven by sales of USB flash drives, MP3 players and digital cameras.

In recent weeks, SanDisk has come out with a slew of announcements in these markets, which has also helped shares. That included the launch of SanDisk's latest MP3 player on Tuesday, as well as a new secure flash memory chip last week for use with portable music and video players.

Going Mobile

But what really gets SanDisk bulls salivating these days is the still-fledgling mobile-phone market. At the same time Apple unveiled the nano, the company also took the wraps off its first iTunes phone, from Motorola ( MOT), which will be able to store up to 100 songs with NAND flash memory from -- you guessed it -- SanDisk.

"The wireless business is big," Mowrey said, noting that tens of millions of mobile phones get sold each year. "It's a lot of chips."

In his monthly report on the flash market, WR Hambrecht analyst Daniel Amir said he believes that this will be the first holiday season the market will notice handsets with removable memory cards as a growth driver for NAND flash.

"With over 300 models by year-end of handsets with removable card slots, we believe that this is to be a big growth driver for NAND flash in 2006," added Amir, who has a buy rating on SanDisk and whose firm hasn't done banking with the company.

Although investors and analysts foresee a strong holiday season for flash, there's disagreement over the company's more immediate third-quarter results, to be announced Oct. 20.

Amir, whose price target of $52 was reached by SanDisk Tuesday, said he believes that the stock could still move up if SanDisk reports strong numbers.

The company gave a conservative outlook that included flat sales and lower margins compared with last quarter, when SanDisk brought in 32 cents a share on $515 million in sales. "It's probably unlikely the company will come in that low," Amir said.

The current consensus estimate gathered by Thomson First Call forecasts earnings of 35 cents a share on $522 million in revenue.

In his downgrade of SanDisk Thursday to market perform from buy, C.E. Unterberg Towbin analyst Rick Faust said many investors also are expecting a strong outlook for next year, pricing in earnings per share of at least $2 vs. the consensus estimate of $1.95. That leaves little margin of error, he said. "We would remind investors that NAND is ultimately a commodity, and forward PE multiples would likely compress," Faust wrote. His firm has done investment banking with SanDisk.

In another downgrade, Citigroup analyst Craig Ellis actually raised his 2006 EPS estimate on SanDisk far beyond the $2 mark. Ellis, who cited valuation in his downgrade, increased his target to $2.57 from $2.15 to reflect higher royalties, handset memory card and traditional card revenue. However, he acknowledged his '06 target is approaching a "best case" scenario. (Citigroup has done non-investment banking work for SanDisk.)

SanDisk has delivered earnings upside every quarter except one since at least Sept. 2003, with the surprise averaging 6 cents per quarter, according to Thomson First Call.

But Mowrey worries that SanDisk may not be able to please the crop of momentum investors who have jumped into the stock.

"I don't think estimates are too high, but what might be too high are expectations that they'll blow away those estimates," he said, referring to the so-called whisper-number effect.

Look for the third quarter, then, to ultimately reveal whether investors who have been bidding up SanDisk shares are true believers or short-term speculators.

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