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Julian Close's Insights

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Julian Close
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April 8, 2013 - SanDisk: Apple's indispensable ally

Apple has been one of the most extraordinarily innovative companies in American history, going back all the way to the advent of the first home computers. Even after the departure of its visionary founder Steve Jobs, and after it ceased to be the biggest home computer company, Apple unveiled a continuous stream of user interface and design improvements which became almost instant industry standards. Where Apple lead, others followed, and copied. Unfortunately for Apple, some of its followers and copiers were more shrewd (or perhaps just more ruthless) than Apple was prepared for, and for many years Apple was relegated to the role of a niche player in the computer market. Fed up, Apple famously sued Microsoft for copying the look and feel of its graphic user interface, and perhaps bet too heavily that they would win; they didn't, and the defeat kicked off some truly lean years for the company.

Then came the comeback. Actually, there were two comebacks, as Steve Jobs returned to Apple, and Apple returned to profitability, riding a wave of new innovations, starting with the iMac, then the iBook, the iPod, the iPhone, and the iPad. As long as Apple had Steve Jobs, it had a golden touch, which is why Jobs's death has left a question mark over the company: will Apple continue to be as innovative in his absence? So far, at least, the street doesn't seem to think so.

As of now, the mighty Apple appears to be falling to Earth, (Newton would be proud) and its share price is down 30% from its high. Of course, Apple still sells a tremendous number of products and still has a fanatically loyal base of customers, for some of whom, it is Apple or nothing. Apple is locked in a head to head battle with Samsung for dominance in the enormous and growing mobile phone industry, and it still holds the dominant spot in the tablet market (that it created itself), though its dominance does seem to be eroding somewhat as more companies release products with overlapping feature sets to the iPad.

So what is an investor to do with all this uncertainty? We believe the best way to make money off of Apple is avoid the company's stock entirely and focus instead on another company that is pulled along in Apple's wake. Over the past year, Apple has been obtaining more and more components from SanDisk (SNDK), a company best known for flash memory, but which makes solid state drives which are now being used in MacBook Pros as well.

More importantly, the iPhone 5 is now using SanDisk's flash memory. The additional business should be a real boon to SanDisk, and Apple is likely to use more SanDisk memory in the future, not less, as the alternative, strangely enough, is Samsung, Apple's rival for dominance in the phone market. As the competition for market share has gotten somewhat heated, Apple finds it hard to swallow the idea of making Samsung money every time it sells an iPhone.

We are making a bull-put credit spread on SNDK. Buy the July 41 put and sell the July 45 put for a credit of at least $0.42. That is an 11.7% return, or a 40% annualized return (for comparison purposes only), and the stock has to drop 17.9% to threaten the trade. As this trade involves risk, it is best suited for investors with diversified portfolios.

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