Western Digital's (WDC -1.25%) lengthy attempt to acquire Toshiba's (TOSBF) memory unit failed last month, with Toshiba deciding to sell the unit to a consortium led by SK Hynix and Bain Capital.
Western Digital previously inherited a NAND flash memory joint venture with Toshiba through its $15.8 billion acquisition of SanDisk. But shortly after the SanDisk takeover, Toshiba decided to sell its entire memory business to offset losses at its US nuclear division.
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WD opposed the sale, stating that it violated the contractual agreements of the Sandisk joint venture. Toshiba, which stated that WD lacked the capital for a full buyout, sued WD for interfering with the deal. WD eventually assembled a consortium of companies to make a bid for the unit. However, its final bid of $17.4 billion still fell short of the $18 billion that SK Hynix and Bain's consortium offered.
That loss sparked several downgrades of WD from analysts, who noted that NAND prices were gradually peaking and WD's own NAND supply faced an uncertain future. So is it finally time to sell Western Digital after its near-60% run over the past 12 months? Or does this data storage stock still have room to run?
Why Western Digital needed Toshiba's memory business
Prior to the SanDisk purchase, most of Western Digital's revenue came from sales of traditional platter-based HDDs (hard disk drives). However, HDDs have been gradually replaced by SSDs (solid-state drives), which use NAND flash memory chips instead of platters. NAND-based drives are smaller, faster, consume less power, and are less prone to damage because they don't have any moving parts.
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Samsung (NASDAQOTH: SSNLF) is the largest NAND chip maker in the world, with 35.6% market share during the second quarter. Toshiba and Western Digital, each of which has a 17.5% share, are tied at second place. Micron controls 12.9% of the market, SK Hynix controls 9.9%, and Intel controls 6.6%.
If WD had completely acquired Toshiba's memory business, it could have challenged Samsung for first place. But under the terms of WD's consortium bid, it would have only maintained an 8% stake without any voting rights. That would only have slightly boosted its market share, but it would still have become the second largest NAND maker in the world.
But now SK Hynix will step up and claim a large portion of that business, which could help it overtake Micron and challenge WD's SanDisk with scaled-up operations. Meanwhile, Gartner predicts that NAND prices -- which are already posting slower year-over-year gains -- will eventually crash in 2019 due to the cyclical nature of the market.
But Western Digital and Toshiba could still work together
Back in July, a California court ruled that Toshiba needed to give SanDisk a two-week notice before closing any transfer of its joint venture interests. Shortly after it lost the Toshiba bid, Western Digital also filed for arbitration against Toshiba through the ICC International Court of Arbitration, claiming that Toshiba shouldn't invest in a new flash memory production line unless SanDisk is allowed to participate.
Toshiba is apparently willing to give WD a chance. It recently announced that it was discussing a joint investment in a new chip production line with WD, which could mend some fences between the two companies. During a news conference, Yasuo Naruke, the head of Toshiba's flash memory unit, stated that it was best to maintain "amicable ties" with SanDisk as the two companies both compete against Samsung.
So should you sell Western Digital?
Analysts expect WD's revenue and earnings to respectively rise 6% and 35% this year, with robust sales of SanDisk's NAND products offsetting softer sales of its namesake HDDs. However, WD is now upgrading its traditional HDDs with new features, like MAMR (microwave-assisted magnetic recording) tech which lets HDDs cram in more bits at the same price. Those high-density drives could prove popular in data centers which can't afford to upgrade all their HDDs to pricier SSDs.
WD trades at just seven times next year's earnings, while its closest rival Seagate trades at 10 times forward earnings. WD also pays a forward dividend yield of 2.3%.
That low valuation and decent dividend should limit WD's downside potential -- even after its spectacular run over the past year -- while new technologies like MAMR and a mended relationship with Toshiba could clear up concerns about its HDD and SSD businesses. Therefore, I think investors shouldn't sell WD, since it could still have more room to run.
