In an earlier post I reacted to a letter that activist shareholder Elliott sent to Western Digital’s board asking for the company to be split into two parts, one for HDDs and the other for flash. I wrote it before learning that the Elliott letter was posted on the web for public viewing.
I found Elliott’s proposal hard to rationalize.
Although the reasoning I shared in that post is solid, I learned when I read the Elliott letter that it also uses some very solid logic that approaches the split from a drastically different perspective, and from that perspective a split indeed makes sense.
How can that be? Well, to save you from having to read all 13 pages of the Elliott letter, I will offer a re-cap in bullet format:
- WDC’s acquisition of SanDisk for $19 billion in 2016 was intended 1) to combine a broad portfolio of technologies to create synergies, 2) to improve strategic positioning with customers, and 3) to enhance WDC’s financial profile. None of these benefits have been realized.
- Western Digital has consistently lost share in both HDD and Flash since then.
- At the company’s Investor Days in 2016 and 2018 Western Digital laid out an array of long-term financial targets which management claimed would not be possible for a standalone HDD business, yet none of these targets were achieved.
- At the time of the SanDisk acquisition WDC stock was at $75 per share, but now it has dropped nearly 30% to $53, while, over the same period the S&P 500 grew 103% and NASDAQ by 190%. Meanwhile, Seagate has outperformed WDC by 229% since the SanDisk acquisition.
- Western Digital’s market capitalization is lower than Seagate’s despite having 60% more revenue. Western Digital’s market cap is $21 billion with revenue of $19 billion—a 1.1x multiple, while Seagate’s market cap is $22 billion, with lower revenues of $12 billion—a 1.8x multiple. WDC’s market cap of $21 billion is $13 billion below the $34 billion combined market cap of WDC and SanDisk at the time of the acquisition. Over the same period, Seagate grew its market cap from $17 billion to $22 billion.
- Based on competing companies’ trading prices, Western Digital’s HDD business can be valued at approximately $17 billion, and its Flash business, $17 to $20 billion.
- Elliot says: “We believe that ownership of HDD and Flash together has not created tangible strategic benefits, but rather significant detriment,” adding that WDC’s current valuation reflects their investors’ opinion that owning HDD and Flash together works against improved operational and financial performance. The company failed to achieve the anticipated benefits from its SanDisk acquisition, resulting in reduced market cap and shareholder returns. “Western Digital has underperformed its strategic aspirations, and investors’ profound lack of confidence in the Company is evident in the extraordinary discount at which they value its stock.”
- WDC’s stock-price has not improved despite its recent management change. Elliott believes that this reflects continued investor skepticism about the company’s ability to execute on its strategy with the combined HDD/NAND portfolio.
- Despite the company’s 2020 split into two parts for HDD and flash, the investment community has not been persuaded that this step has solved the problem.
In essence Elliott is telling us that the stock market doesn’t appreciate what has happened at WDC since its SanDisk acquisition, and Elliott wants to put things back the way they were, when valuations were higher.
To that end, Elliott proposes a split to create two companies, one for HDDs and one for flash, and is offering to help the transition with an infusion of cash. Elliott’s goal is to double WDC’s share price by the end of next year to over $100.
The company does realize that there are probably benefits in having the HDD side and the flash side work together, so Elliott proposes that the company’s current collaboration between HDD and Flash “…can be maintained through a thoughtfully constructed commercial agreement to ensure both businesses can succeed independently without sacrificing initiatives that would benefit from ongoing partnership.” Examples of such collaboration include not only sales and marketing that links SSD and HDD businesses, but jointly-developed products like OptiNAND, an HDD that uses NAND to accelerate its accesses, or the new WD Black 850 SSD, which predictively loads its DRAM cache, borrowing the prefetching techniques used in HDDs, to accelerate game play.
To prove that the benefit of a break-up isn’t simply theoretical, Elliott provides the example of Dell’s spin-out of VMware in which Elliott facilitated a successful spin-out resulting in a 78% return to investors.
The SSD Guy has to admit that there’s a lot of logic in this. If investors dislike a company they will drive down its value. I can’t say how they would have justified this, and that would involve a lot more research than I plan to devote to the subject, but I am satisfied with Elliott’s finding that the SanDisk acquisition has been unpopular, and regaining popularity should boost the company’s stock.
There is numerical analysis, and there is popularity, and between this post and my previous one you have both sides of the argument both in favor of and against a WDC split up. Meanwhile, I plan to stand back and see what happens.
(Thanks to reader Jon Forrest for catching an error – now corrected!)
