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Seagate (NASDAQ:STX) has effectively put themselves up for sale, presumably to a private equity buyer. However, last night Western Digital (NASDAQ:WDC) may have just ended all deal talks.

WDC guided to an earnings range of $.50 - $.60 for the next quarter, down from expectations of $.93. The point isn’t that earnings are now under pressure or that there is excess supply and will be for several quarters, or that Seagate doesn’t have 60% market share of the enterprise market. All of those are true.

No, the real issue is the balance sheet of Western Digital. Western Digital has $2.4 billion in Net Cash. Net PP&E at WDC is $2.245 billion. Western Digital has the financial capacity to increase their operating capacity by 100%. WDC calculates their overall market share as 30%+. As of July 2, 2010, Seagate had Net Cash of $456 million. A private equity deal of Seagate, at the rumored valuation of $7.5 billion or so, would end up having a net cost of about $7 billion to the PE buyers. At an assumed mix of 65% Debt and 35% Equity capital structure, Seagate would have $4.55 billion of Debt on a Net PP&E base of $2.263 billion.

The Net PP&E of WDC and STX are quite similar and yet their capital structures, after a STX deal, would be completely different. No PE buyer should ever buy into a capital intensive industry with competitors who have large amounts of excess capital. The fact that the industry is currently over-supplied only shows how easy it would be for WDC to step on the gas and cripple a debt-laden STX.

If STX gets bought, short the bonds and go long WDC. Until then, this is an industry with excess operating and financial capacity.

Disclosure: Alpha Investment is currently recommending positions in STX and WDC.

Source: Seagate: How Western Digital Just Blew Up the Deal