Activist investor Elliott Management says the shareholder value of Western Digital would be much greater if its disk drive and SSD businesses were separated. Does it have a point?
The rationale is that WD is the only combined HDD and SSD business in the market, and this combination has (a) been rejected by other companies and (b) caused WD to under-perform compared to its main peer, Seagate. Specifically, its SSD unit is greatly undervalued by investors. Free this unit from WD and it could be transformed into a much more successful business, rewarding investors with substantial returns.
In a letter to WD’s board and shareholders, Elliott dangles a great big carrot: “By executing on a separation, we believe Western Digital’s stock price could reach $100+ per share by the end of 2023, representing uniquely attractive upside of approximately 100 per cent.” It even says it would invest more than $1 billion of its own money to help bring such a split into being.
SSD/HDD combo is wrong
Elliott criticizes WD for its unique NAND/SSD/HDD combination, saying it is not synergistic. Other companies have exited such a setup.
Elliott states that since WD’s 2016 acquisition of SanDisk, “Western Digital has consistently lost share in HDD, while Seagate, its pure-play competitor, has gained share. In Flash, Western Digital has also lost share, as its bet on leveraging the HDD combination has failed to yield any benefit. In contrast, Seagate is #1 in HDD without a NAND business, and Samsung is #1 in NAND after having sold its HDD business to Seagate a decade ago.”
Japanese conglomerate Toshiba used to have a disk drive business, a NAND foundry, and an SSD business (Toshiba Memory Systems). Under severe financial pressure from its Westinghouse nuclear power station debacle, it sold off 60 per cent of the NAND business to a Bain-led consortium, retaining a 40 per cent interest in the resulting Kioxia business.
Samsung also had an HDD business and sold this to Seagate in 2011, concentrating on its DRAM and NAND fab/SSD businesses as far as storage is concerned. But Samsung is not a pure-play DRAM/NAND business – it’s a massive conglomerate with numerous other interests in the electronics sector. Also it had a trivial share of the HDD business and probably saw no possibility of becoming a leading HDD supplier. There was no strategic mismatch between SSDs and HDDs there.
Elliott reckons Seagate “has remained a pure-play with no captive NAND manufacturing business.” That there is no NAND manufacturing is true but Seagate does have an SSD business, albeit a minor one. Technically, Seagate is a combined HDD and SSD business and not a pure-play disk drive manufacturer, so this part of Elliott’s critique is weak. None of its three examples have separated their HDD and SSD businesses because of inadequacies in their ability to manage the two businesses in tandem.
Realizing the SSD business’s value
The second overarching point made by Elliott is that WD’s NAND/SSD business has under-performed relative to its peers and also to WD’s stated plans. Its letter points to WD having not fulfilled financial targets because of this.
“Today, Western Digital has an enterprise value of $21 billion with revenue of $19 billion – a 1.1x multiple. This valuation compares to the combined $34 billion pro forma enterprise value of Western Digital and SanDisk when they announced the acquisition six years ago, representing $13 billion of value loss. By contrast, in the same period, Seagate grew its enterprise value from $17 billion to $22 billion, with revenue of $12 billion – a 1.8x multiple. Despite having 60 per cent more revenue than Seagate, including $10 billion of Flash revenue, Western Digital’s enterprise value is now well below Seagate’s.”
Quoting statistics like this is like shooting fish in a barrel. But valuing a separated NAND/SSD business is hard. Elliott admits this: “None of the publicly traded companies are pure-play NAND businesses, which makes valuation comparisons between these companies difficult. There are no other pure-play businesses like this, except Kioxia, and that is not publicly owned.”
Elliott reviews the history of NAND M&A transaction multiples for valuation guidance:
- WD bought SanDisk in 2016 for $17 billion – a multiple of 3.0x LTM (last 12 months revenue);
- Bain Capital paid $18 billion for Toshiba Memory in 2018 – 1.9x LTM;
- SK hynix bought Intel’s NAND business in 2020 for $9 billion – 1.8x LTM;
On this basis, Elliott believes “Western Digital’s Flash business can be worth $17 to $20 billion, or 1.5x to 1.75x 2023 revenue.”
Recognizing there was unfulfilled potential, WD CEO David Goeckler reorganized the HDD and NAND/SSD operations into two separate business units in September 2020. But Elliott says there has been no tangible benefit from this because the reorganization didn’t go far enough – that is, it didn’t split off the SSD business.
No synergy
Elliott’s letter consistently points to a lack of synergy between WD’s disk and flash businesses. OptiNAND is not mentioned in Eliott’s letter to WD shareholders, either through ignorance or choice.
The company has used its NAND technology to increase HDD capacity through higher disk track density with its OptiNAND drives. It has added an iNAND embedded flash drive to the SoC-based disk drive controller and storing metadata in that instead of the actual platters. By using this technology, WD sees a path to 50TB drives in the 2025–2030 period.
In our view, it needs to demonstrate faster HDD capacity growth and better price/performance than both Seagate and Toshiba for this synergy argument to have any force.
Analyst’s view
Elliott can point to financial analysts’ views of WD that support its argument that WD’s flash business is undervalued by investors.
For example, a Citi article in March 2022 read: “The board of directors, senior management and shareholders should be aware of the potential value unlocking via the sum of the parts, splitting up the company, and perhaps the most likely course of action of simply getting its internal operations to post consistent solid results.”
Wells Fargo’s Aaron Rakers wrote: “We view Elliott’s offer as a validation of our view that there should not be a significant disparity on the valuation of Seagate and Western Digital’s HDD business … and that the company’s Flash business is undervalued.”
The thrust of Elliott’s letter to the WD board is that it needs to boost its share price by greatly increasing its SSD unit’s revenues and also growing HDD revenues faster than Seagate. If it can’t do this Elliott, as one of WD’s largest shareholders, will agitate for an SSD unit sale, spin-off or merger, and pursue board-level representation (directorships) to get its way.
