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Flash Finds Some Fans

An analyst's upgrade sends shares of SanDisk and M-Systems surging.

Shares of flash memory makers






each surged more than 8% in Monday trading following a bullish report by Citigroup that upgraded both chip companies.

While concerns of recently announced price cuts and a near-term oversupply of flash memory have put pressure on the stocks for the past month, Citigroup analyst Craig Ellis wrote that the picture gets rosier beginning in the second half of the year.

"Early evidence of tempered supply growth is now forming, just as SanDisk's product refresh approaches, while second-half seasonal strength for MP3 players, handset memory cards, and USB drives is just a quarter and a half away," wrote Ellis, upgrading his ratings for both SanDisk and M-Systems to buy.

Citigroup owns shares of both SanDisk and M-Systems, has provided investment banking services to M-Systems within the past 12 months, and non-investment banking services to both SanDisk and M-Systems in the past 12 months.

Sunnyvale, Calif.-based SanDisk was up nearly $5, or nearly 9%, to $61.31. M-Systems rose more than $2 to $27.85.

Companies like SanDisk, M-Systems and


, the world's No. 1 flash company, have benefited from consumers' seemingly insatiable appetite for cell phones, MP3 players and other electronic devices that use flash memory chips. Unlike conventional DRAM memory, flash memory chips can retain data even when power is cut off, making them ideal for storing digital music, photos and other types of data.

SanDisk generated $2.3 billion in revenue in 2005, up 30% from the prior year, with $2 in EPS. In January, however, the company announced that it would aggressively slash prices in 2006 in order to stimulate demand for the newer, higher-capacity flash memory products coming off its assembly lines. Since then, the company's stock has declined roughly 20%.

Ellis lowered his gross margin estimates for SanDisk over the next three years to reflect the impact of the price cuts, but raised projections for the overall amount of bits the company will sell during that time.

He also noted that there was potential for royalty upside from a possible intellectual property agreement with South Korea's

Hynix Semiconductor


"We argue to build positions patiently over the next three months and ahead of mid-to-late year gross margin acceleration, potential positive royalty revenue estimate revisions, and broader new product launch activity in the NAND space, all of which we believe will drive 2H

second-half seasonal strength," Ellis wrote.

M-Systems' 18 times multiple on 2006 earnings and 12 times on 2007 EPS, means the shares are the cheapest they have been since August 2005, Ellis also noted. The company's increasing strength in its core cell-phone handset business and growth in its private-label USB flash drive business should buoy the top line, prompting Ellis to boost his revenue estimates for M-Systems for 2006 through 2008.