The LEAPS Option Trader
105 W. Monument Street
Baltimore, MD 21201
Friday, October 7, 2005
Email – #280
** Flash Profits
Earlier this week we closed out our Lexar Media (Nasdaq: LEXR) bull spread for profits of 66% plus. The shares were strong, blowing through the upper end of our spread. Now they have weakened slightly due to the weakness in the market and normal consolidation after such a strong run.
Yet, there are still reasons to be in LEXR. The company still stands to benefit from a massive settlement with Toshiba, one that is in the appeals process now. The court is set to rule any day now on another issue: whether LEXR is entitled to the jury award of almost a half-billion dollars. If that occurs, as I believe it will, LEXR will also be entitled to interest on the award while it is being appealed. That interest is between $60,000 and $100,000 PER DAY. Strong incentive for Toshiba to settle.
Secondly, LEXR is also involved in a major lawsuit with Fuji. The resulting award could be close to the Toshiba amount, another $400 million-odd dollars. Chances of LEXR winning are good to excellent.
The reason that LEXR is winning these suits and settling with companies like Memorex is quite simple. These companies have in one way or another taken LEXR’s technology and sold products based on it without compensating the company. Once the jury is shown this easily traceable source technology for flash memory and other memory systems, it is a pretty easy decision. What slows the process down is the multitude of lawyers and their incessant motions, which drag the cases to a crawl. With hundreds of million of dollars at risk, you can see why the infringing party wants to make winning as difficult as possible. Toshiba tried and lost, and now it is appealing.
In the meantime, LEXR is not running in place. It has agreements in place to provide its patented technology to companies like Sandisk, Sony and a host of others… including the infringers. Digital media is hot, and LEXR’s digital and flash memory is in demand. It will sell almost $800 million in products this year. The number would be much higher if the parties that are illegally using its technology actually paid the company.
LEXR’s market cap is less than its annual sales. It competitors trade at between four and five times sales. There is potential here for a huge run-up in price, if LEXR can collect from Toshiba and then Fuji. In fact the Toshiba settlement would be almost equal to the company’s share price in cash.
LEXR has not gone unnoticed. We got in early six months ago, and since then the shares have moved higher on analyst upgrades. But there is more room to go. Unfortunately, LEXR’s options are expensive relative to the share price – that is why we got out earlier this week with some major profits.
But this time, we are setting our sights higher. We are going to mitigate some of the price, and invest in LEXR using a bull spread – with a chance to more than triple our investment. I think that LEXR can trade much higher if all the pieces fall into place, but it may take time for some of the events mentioned above to take place. That is why we are using LEAPS.
Also, if the settlements do not work out, if Toshiba wins or drags out the appeals process, then we could see a plunge in the share price. That is the risk.
Here is what you should do: Buy the LEXR January 2007 $7.50 calls (VRF AU). These are trading for $2.40. Against this position sell the LEXR January 2007 $12.50 calls options (VRF AV). These are trading for $0.95. Your net debit (cost) for this bull spread will be around $1.45 with an upside of $5, for returns of more than 244% if the shares close above $12.50 at expiration. Of course, we may exit the position early if the shares move higher faster, as we did the first time. Because both options move in tandem, for now, you should be able to achieve a net debit of $1.45 to $1.50 on this trade – use this as your guideline.
Regards,
Karim Rahemtulla
