Western Digital: Long-Term Appeal Remains After Another Strategic Acquisition

Sep. 9.13 | About: Western Digital (WDC)

Shares of Western Digital (WDC) hardly moved on the news of yet another deal to bolster its presence in the enterprise SSD market.

The third acquisition within three months' time underscores Western Digital's commitment to the enterprise SSD market to bolster future growth, its competitive position, and the offerings in the software market.

The solid financial position, appealing valuation, and commitment to create future shareholder value makes me optimistic about the long-term prospects of the firm.

The Deal

Western Digital announced that it has entered into a definitive merger agreement under which it will acquire Virident Systems.

Western Digital will pay $685 million in cash for the provider of server-side flash storage solutions.

Virident focuses on technology for the enterprise and cloud-computing industry. Virident's offerings provide customers with server-side flash storage, which accelerates virtualization, database and cloud-computing solutions. Key in all this is the FlashMAX II product.

With the deal, Western Digital and is subsidiary Hitachi Global Storage Technologies (HGST), will boost the presence in the enterprise SSD market. The market for enterprise SSDs is expected to nearly triple between 2012 and 2017, growing towards $7 billion in 2017.

Combined with Virident, HGST can increase go-market times and boost the value of its offerings to customers. The increasing storage demand and capacity boost the importance of intelligent storage solutions. The 175 employees of the Virident, which was founded as recently as 2006, will become part of HSGT. CEO Steve Milligan commented on the rationale behind the deal:

We have established a competitive position in the enterprise SSD space and with our recently announced acquisitions we are increasing our commitment to become an even more significant player in this high growth segment.

The deal is of a highly strategic nature, and will not add meaningfully to earnings and revenues in the short term, although Western Digital believes the deal will add to non-GAAP earnings in 2015.

The deal is subject to normal closing conditions, including regulatory review, and is expected to close in the fourth quarter of 2013. Early strategic investors in Virident include Cisco Systems (NASDAQ:CSCO) and Intel Corporation (NASDAQ:INTC).


Western Digital ended its fiscal year of 2013 with $4.31 billion in cash and equivalents. The company operates with $1.95 billion in total debt, for a net cash position of around $2.36 billion.

Annual revenues for the year came in at $15.35 billion, up 23.0% on the year before. Net income rose slightly to $1.7 billion, coming in at $6.75 per share.

Trading around $65 per share, the market values Western Digital at $15.5 billion, valuing operating assets of the firm at $13.2 billion. This values operating assets of the firm at 0.85 times annual revenues and 7-8 times annual earnings.

Western Digital pays a quarterly dividend of $0.25 per share, for an annual dividend yield of 1.5%.

Some Historical Perspective

The long-term performance of Western Digital has been a success story. Over the past decade, shares have almost 10-folded from levels around $7 in 2004, to highs of $70 in recent weeks.

As a matter of fact, shares have returned some 55% in 2013 alone, as operating performance kept improving. Between the fiscal year of 2010 and 2013, revenues rose by a cumulative 56% to $15.4 billion.

Investment Thesis

Western Digital continues to commit to solid-state drives, as it battles with Seagate Technology (NASDAQ:STX) to be a leader in the fast growing market for SSDs used in servers. Crucial in all these developments is the blurring of functions and integration of database applications, processing and actual storage.

Western Digital, which is focused on hard disk-drive markets has shifted its focus to faster and more energy efficient solid-sate drives to combat the slowing PC market.

The rumors about further consolidation in the market has pushed up shares of competitor Fusion-IO (NYSE:FIO) by almost 25% in Monday's trading session.

Analysts expect that the company will be acquired by Seagate, which is left out after missing out on Virident. Seagate already publicly announced its intentions in the field. Western Digital admitted on the conference call that there were other bidders involved for the company.

Back in June, when Western Digital announced the acquisition of troubled SSD producer STEC for $340 million, I last took a look at the company's prospects. Ever since, shares have risen from $60 to highs of $70, currently trading at $65 per share. Just like that deal with STEC, it is not about the current revenues or earnings, which the companies contribute. Rather it is the promising build up of a fast growing division, driving future revenue and earnings growth.

These deals are of a highly strategic nature, as Western Digital has already spent a combined $1 billion to acquire STEC and Virident. The fact that this second deal takes place within three months of STEC just shows the commitment the company has made. In the meantime, the company acquired privately held VeloBit as well, for an undisclosed sum.

I applaud management's strategy. The company is willing to invest 5% of its market capitalization in another promising firm to built an anchor for future growth. For the full year of 2013, the Enterprise SSD business generated annual revenues of $355 million. The move away from hardware into software, might boost valuation multiples along the road as well.

Yet the company holds sufficient cash to finance these deals, still operating with a solid net cash position following the deal. Solid operating cash flows continue to provide a source of cash to be deployed in the meantime.

The overall valuation remains appealing enough despite an almost 10% run up over the past three months, and year-to-date returns of 55%. I remain cautiously optimistic given the solid state of finances, the appealing valuation at 8 times last year's earnings despite the cyclical nature of the business, and management's commitment to bolster the strategic foundation of the firm.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.