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How Elliott Associates’ proposal to split two businesses at Western Digital may build value


The Western Digital building can be seen in Irvine (California), U.S.A, 24 January 2017.

Reuters| Reuters

Company: Western Digital, (WDC).

Business: Western DigitalA leading manufacturer and developer of data storage products and solutions, it also operates in two highly-respected franchises hard disk drives (“HDD”) as well as NAND flash (“Flash”) which is its primary market. The $19 billion SanDisk acquisition in 2016 brought these two companies together. It allowed the company diversify the nearly 50-year-old business from HDD, and made it one of the most prominent Flash players in the sector.

Stock market valuePrice: $18.6B (59.45/share)

Activist: Elliott Associates

Percentage of Ownership ~6.0%

Average cost: n/a

Commentary of an activist:Elliott is an extremely successful, astute activist investor, especially in the tech sector. Their team includes analysts from leading tech private equity firms, engineers, operating partners – former technology CEO and COOs. They also employ industry experts, cost analysts, and specialist management consultants when evaluating investments. These people often spend years watching companies before they invest and are well-versed in the selection of board members.

What’s Happening?

You can find more information here May 3, 2022Elliott wrote a letter to Western Digital’s Board expressing his belief in the separation of its NAND flash storage business. Elliott requested that the board conduct an extensive strategic review. It expressed the belief in the possibility of a stock price increase of up to $100 per share before 2023.

Behind the scenes

We have witnessed a lot of activism to “sell the company”, as new activists enter the fray. There is no plan, and there are few reasons why. This type of activism is short-term and greedy, which we have criticized. If activists don’t understand our criticism, they should see Elliott’s letter. It is a great example of shareholder-focused, well thought out strategic activism. Elliott offers a 13-page explanation of the reasons why two companies should be seperated and the plan for achieving that separation.

It is one of the world’s largest suppliers of data infrastructure storage components and built an impressive HDD business. The HDD market began to decline as notebook and desktop PCs switched over to faster NAND flash solid state drives (SSDs) in 2013. In 2015, however, the HDD industry experienced a slow decline as notebook and desktop PCs switched to faster NAND flash solid-state drives (SSDs).he company announcedTo enter the Flash sector, it purchased SanDisk for $19 million. After this purchase, HDD rebounded. It is now an industry that has seen growth. Western Digital, which was second behind Seagate, became one of the dominant suppliers of HDD technology. Western Digital operates today in HDD as well as NAND flash.

Over the last six-years, they have underperformed in several key areas. They have failed to realize the synergies between a combined HDD/Flash portfolio, and have seen a loss of market share for both HDD- and Flash. Operational missteps consistently lead to financial goals not being met, including revenue compound annual growth rate (CAGR), gross margins and operating expenses. Third, the company has poor stock price performance, returning -23.10%, 6.14% and -39.57% over the past 1-, 3- and 5-year periods versus -0.89%, 41.07% and 74.0% for the S&P 500, respectively. 

Elliott convincingly argues that Western Digital’s poor performance is caused by the incompatibility of its two businesses. While both companies are strong and share a lot of market, they would offer significantly greater value as separate businesses. Flash and HDD are completely different technologies. Flash uses spinning disks instead of leading-edge semiconductor devices. While the business may share customers with each other, manufacturing is distinct and products are not necessarily in competition for certain applications.

Before the SanDisk purchase, Western Digital had an inexorable higher price-earnings rate than Seagate. Seagate’s current price-earnings ratio is significantly lower than that of Western Digital. Western Digital today has an enterprise worth $21 billion. This is compared with the $34 billion combined enterprise value of SanDisk and Western Digital six years ago. That’s $13 billion in value loss. Seagate, on the other hand, saw its enterprise value grow from $17 billion up to $22 billion in that time period. Western Digital acquired SanDisk in 2005. The stock traded at $75 per unit. The stock is now worth $53 per share, nearly 30% less than it was six years ago. In the same time period, the S&P 500 and Nasdaq increased by 103% and 190%, respectively. Seagate, the company’s nearest HDD peer has outperformed Western Digital with 278% in the last decade. Micron has also outperformed Western Digital with 868% during the same period.

Elliott thinks Western Digital’s value today is reflective of the view of investors that Flash HDD and Flash jointly creates an overlapping of synergies. This could lead to a reduction in operational and financial performance. The company is being asked to consider a complete separation of Flash. This could allow for a stock market price of at least $100 per share.

Western Digital HDD has 38% market share (versus Seagate’s 46%), $9.4Billion of revenue (versus Seagate’s $12Billion), and a 21% rate of growth (versus Seagate’s 18%). They also both have a 30% gross margin. Western Digital’s HDD company would be worth $17 billion if it was valued at 1.8x LTM revenues and 6.1x LTM profit using Seagate’s multipliers.

Western Digital’s Flash business is worth $10 billion. Similar businesses have also been purchased at multiples 1.7-1.x revenues. According to this, the Flash business has a potential value of $17 trillion. This isn’t the usual call for strategic actions. Elliott has offered $1 billion in incremental equity capital to the Flash company at an enterprise value between $17 billion and $20 billion. This can either be used in a spinoff transaction, or equity financing in a merger or sale with a strategic partner. With a $1B investment, Elliott is basically expressing his willingness to invest in the Flash company’s acquisition. Elliott values each company at $17 billion. The total enterprise value is $21 billion.

Elliott could get the Flash business sold at what they have invested their money into, which would give the HDD business a valuation of $4 billion. The Flash business is a good investment. This combination of Western Digital’s Flash and its joint venture partner Kioxia gives reason for optimism. Western Digital interest in acquiring KioxiaThis has been documented well over the years. a proposal in 2017The rumored $20 billion transactionValue last year was 1.7% of LTM revenue. Kioxia was publicly reported to have received interest from many other financial and strategic parties over the last five years.  

They could find favorability with current company board members and managers. SanDisk’s acquisition decision predates its CEO David Goeckeler and his management team. Nearly all were recruited in 2020. Goeckeler made his first operational move by separating HDD/Flash within Western Digital. Although it isn’t a difficult task to convince the board of separating the company into different companies, especially since only two out of the ten current directors for Western Digital were involved in the SanDisk purchase. Additionally, shareholder activism revolves around the power and persuasiveness of arguments and Elliott has a compelling case.

Also, it should be mentioned that Elliott claimed to have invested approximately $1 billion in the company and has yet to file a 13D despite holding a mere 6% stake. Their history and their philosophy suggest that this is because Elliott uses swaps and derivatives to build his position. These types of securities do not need to be part of “beneficial ownership” in order to file 13Ds. This is the topic of the current Securities and Exchange Commission proposal and it could change quickly, forcing Elliott file a 13D to invest in that investment.

Ken Squire founded and is president of 13D Monitor. This institutional research service focuses on shareholder activism. Squire also is the creator and portfolio manager at the 13D Activist Fund. A mutual fund that invests primarily in activist 13D investments, 13D Activist Fund is also his creation. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving ESG practices of portfolio companies.