Western Digital’s Board of Directors was recently sent a letter by activist shareholder Elliott asking for the company to be split into two parts: one for HDDs and one for flash. The reason given was that the company’s SanDisk acquisition was not performing well.
Elliott currently holds a 6% stake in WDC.
According to an article in Reuter’s, Elliot’s letter said:
…operating two very different businesses as part of the same company has held it back, operationally, financially and strategically…
…full separation of the Flash business can allow both HDD and Flash to be more successful and unlock significant value.
The implication is that the flash business is holding down the HDD business. Let’s have a look at that.
Is Flash a Drag on HDDs?
The following charts are taken from WDC’s reported financials for the past several quarters. Certain metrics have not been reported for all quarters, so I provide those that I have access to.
First, let’s look at HDD and flash revenues. It’s pretty clear that flash is pulling out in front:
Flash and HDD revenues are similar to each other, both largely between $2-2.5 billion per quarter for the past two years. The request for a split, though, would seem to stem from margins. Do flash margins undermine HDD profitability? Well, WDC discloses gross profits by business unit, so here’s a chart of those:
Flash profits have been higher for the past two years, and were substantially higher during the 2017 shortage, but 2017 was not like most markets, you can’t count on something like that happening again. Still, from the perspective of profits, it doesn’t appear that the HDD business would gain by being separated from flash.
Another way to look at this would be to look at gross profit margin: “GPM”. This is simply the values in the second chart divided by those in the first.
Once again, flash is ahead of HDD. In fact, flash’s margin is more consistently higher than HDD’s margin than the dollar figures of the second chart would imply.
So, you have flash that seems to be growing a little faster than HDD, its revenues are already slightly ahead of HDD’s, and its profits and margins are usually higher. It’s hard to see why splitting these two apart would benefit the HDD side of the business.
To add a further argument, once the businesses were split certain synergies would disappear. For example, two sales teams would be required for HDD & SSD sales, where today both device types are sold by the same salespeople. A split would not only complicate the picture, but it would also add cost. I am sure there are other synergies that don’t immediately come to mind.
Elliott’s suggestion is to divide the businesses according to manufacturing type. Perhaps a split would make more sense if it were to divide the company according to customer type. WDC sells not only SSDs and HDDs, but it also sells USB flash drives and flash cards. USB drives and flash cards are consumer goods that are mostly sold through retail channels whereas SSDs and HDDs are typically sold to OEMs and other high-volume users.
Both flash drives and cards are more crowded markets – they have many more suppliers, and that puts pressure on margins. Add to that the fact that a lot of the work done by USB flash drives can now be accomplished online (file sharing in particular) and that the work done by memory cards is now largely handled by flash internal to the device: Most people now take photos and videos on their cell phones using internal memory, rather than on cameras that use a memory card. This has constrained the growth of these markets while the high level of competition negatively impacts margins.
Maybe it would be better to split the company between consumer flash products and OEM HDD and SSD storage. This could benefit the OEM business if consumer margins were considerably lower than OEM margins. WDC doesn’t disclose whether or not this is the case.
Still, the consumer and OEM products use shared manufacturing resources, so it’s hard to see why costs or revenues would benefit from a split. For example, the JV flash manufacturing shared by Kioxia and WDC would now split its output three ways, rather than two, and both of the new companies would need to contribute to the JV’s combined R&D efforts. There’s no clear advantage to splitting them up, and there’s every likelihood that a split would result in slightly higher costs for both of the new entities.
Not a New Idea
For some reason the argument to split companies into SSD and HDD businesses has been used many times before. Samsung sold its HDD business to Seagate in 2011 after splitting the once-combined HDD and SSD businesses, and more recently, Toshiba, after merging and unmerging its HDD and SSD businesses, spun off Kioxia, but retained its HDD business.
Thinking Things Through
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