IBM (NYSE:IBM) recently sold over 100 patents to data storage giant Western Digital (NASDAQ:WDC) for an undisclosed amount. The acquired patents -- which are for distributed storage, object storage, and emerging non-volatile memory -- will expand WD's existing portfolio of over 10,000 patents and patent applications. IBM will retain access to those patents through a cross-licensing agreement.
Western Digital's dilemma
Over the past few years, WD's core market of hard disk drives (HDDs) has been commoditized, while the arrival of solid state drives (SSDs) has cannibalized sales of HDDs. Whereas HDDs run on damage-prone platters, SSDs use flash memory without any moving parts. As a result, SSDs are faster, more power efficient, and fit more easily into thin tablets and ultrabooks. These challenges, along with the weakness of the PC market, caused WD's revenue to fall 15% annually last quarter.
To deal with this market shift, WD acquired more HDD and SSD makers. Last year, it agreed to acquire SanDisk (NASDAQ:SNDK) for $19 billion, a massive deal that will require it to take on $18.4 billion in new debt and suspend its buybacks. That acquisition will give WD about a 14% share of the SSD market to complement its 40%-plus share of the HDD market.
Unfortunately, the SSD market is also being quickly commoditized, and analysts expect 3D NAND technology to dramatically narrow the price gap between HDDs and SSDs within the next few years. To make matters worse, sluggish demand for PCs continues to reduce market demand for HDDs and SSDs.
Economies of scale
For Western Digital to survive in the data storage market, it needs to become bigger so economies of scale can lower its production costs. Buying up HDD/SSD makers and IBM's patents all complement that strategy.
For example, acquiring IBM's patents in non-volatile memory can help WD's enterprise SSDs gain ground against Samsung, which controls nearly half the SSD market. Gaining additional storage patents can make its storage devices more appealing than solutions from its industry rivals.
Looking ahead, inorganic growth and new patents can strengthen WD's pipeline, but the company still faces lots of near-term headwinds -- that's why analysts expect WD's annual earnings to grow just 2% over the next five years.
The key takeaway
It's unclear how many new products WD will develop with its new patents, so the long-term impact of this deal can't be quantified for now. However, gaining more patents should be considered a positive development for WD, since it bolsters its ability to create more competitive storage devices.
Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.