32 BARRON’S September 28, 2020
TECH TRADER
The SanDisk acquisition“has played out to be a
failure any way you look at it,” one analyst says.
A Chance to Hit
TheRedoButton
On Western Digital
W
estern Digi-
tal is no
fancy cloud
play, but the
disk-drive
and memory
chip com-
pany has something going for it that
red-hot software stocks like Snow-
flake and Zoom Video Communica-
tions lack—a bargain-priced stock
with real appeal for value investors.
Now to be sure, 2020 has been a
rough stretch for Western Digital in-
vestors. The stock (ticker: WDC) is
down about 35% the year to date, to a
recent $37.53.
Among other things, sales of prod-
ucts sold at retail slumped in the face
of widespread store closures. Sales for
the June 2020 fiscal year were up just
1%—and Wall Street sees a 6% drop in
fiscal 2021.
But let’s not lose sight of the big
picture. The world continues to pile
up data. All those clouds? They’re
basically servers, disk drives, and lots
of cables. Selling storage products is
not a glamorous business, but the
world needs every petabyte the com-
pany can produce.
Western Digital has been evolving,
and there could be bigger changes
ahead. Longtime CEO Steve Milligan
was replaced in March by David
Goeckler, who had spent the previous
19 years at Cisco Systems.
Among Goeckler’s first major
moves was a decision in May to sus-
pend what had been a rich dividend
payout of better than 4%, choosing to
redirect the cash to pay down the
company’s substantial debt burden
more aggressively.
As of the end of the June quarter,
Western had about $6.5 billion in net
debt, most of that tied to the com-
pany’s $19 billion acquisition of flash-
chip maker SanDisk in 2016. While
fiscally wise, suspending the dividend
upset yield-hungry investors, and the
stock tumbled. More recently, Western
shares stock took another hit when
the company announced disappoint-
ing September quarter guidance.
At a deeper level, Western’s woes
date to the SanDisk deal, which was
intended to diversify the company
away from slowing hard drive sales.
But the company’s market cap is now
$8 billion below what it paid for San-
Disk. The acquisition, Craig-Hallum
analyst Christian Schwab recently
asserted, “has played out to be a fail-
ure any way you look at it.”
If only executives could go back in
time and hit the undo button. Well,
maybe they can.
Western Digital shares spiked this
past week after the company an-
nounced a corporate reorganization
that appears to be drawing clearer
lines between the old hard-disk drive
business and the flash memory opera-
tions. The announcement was fuzzy;
the company said that the move “will
align the company’s diversified portfo-
lio to an acceleration strategy de-
signed for growth, profitability and
development agility,” whatever the
heck that means.
The Street’s interpretation is that
Western Digital is setting the stage for
an eventual separation into two
parts—in effect, unraveling the San-
Disk deal. In the wake of the an-
nouncement, analysts whipped out
their calculators and did some sum-of-
the-parts math. Calculating potential
value boils down to figuring out the
value of the two primary businesses.
In disk drives there are only two
companies of any consequence: West-
ern and rival Seagate Technology
(STX). Unlike Western, Seagate re-
mains a pure play bet on the drive
business. Craig-Hallum’s Schwab
notes that Seagate’s five-year average
forward price-to-earnings ratio is 1.4
By Eric J. Savitz
times. He sees Western’s drive busi-
ness reporting $7.7 billion of revenue
in the June 2021 fiscal year, which
suggests a valuation of $10.7 billion.
And then there is the flash busi-
ness. Schwab values that unit at 1.9
times estimated fiscal 2021 revenues
of $7.6 billion, based on the five-year
average forward multiple for memory
chip specialist Micron Technology
(MU). On that basis, he concludes that
the flash business is worth $14.6 bil-
lion. Back out $6.5 billion in net debt,
and—voilà!—you get a valuation of
$18.8 billion, or about $62 a share, and
a potential gain of more than 50%.
Sidney Ho, an analyst with
Deutsche Bank, approaches the ques-
tion in a different way, but gets a simi-
lar result. Western sources all of its
flash memory chips from a joint ven-
ture with Kioxia, formerly Toshiba ’s
flash memory business. Kioxia is go-
ing public in Japan on Oct. 6, at an
expected valuation of $14 billion to $18
billion.
In a recent note, Ho adds the cur-
rent market (around $11 billion) to the
outstanding debt, backs outthe hard
drive business using a valuation com-
parable to Seagate’s and concludes
that the market is valuing the flash
business at just $3 billion. That sug-
gests a gap of well over $10 billion
between the likely valuation of Kioxia
and the market value of Western’s
flash business, despite the fact that
they evenly split their flash memory
production. Ho concedes that some of
the discount could reflect “differences
in operations, go-to-market strategy,
and assets owned” by the two compa-
nies. But he concludes that these rea-
sons do not justify a discount of more
than $10 billion. In short, Western
Digital would appear to be worth
more—and potentially a lot more—
than the market has been thinking.
The company won’t comment on
the speculation surrounding this past
week’s announcement.
Nonetheless, Western’s move to
more clearly define the business just
might reflect that the company’s board
and its new CEO have reached a simi-
lar conclusion—and have decided to
do something about it.B
Courtesy Western DigitalWall Street sees Western Digital’s planned
reorganization as setting the stage for a sep-
aration of the disk drive and flash memory
businesses—which could unlock significant
shareholder value.