Western Digital: The Glaring Valuation Discrepancy

| About: Western Digital (WDC)

A review of the purchase price WDC paid for Hitachi's Hard Disk Drives (HDD) business is opportune.

The deal was agreed 2 years ago, prior to the Thai floods and the consequent change in the supply of Hard Disk Drives. It was prior to the consolidation of the HDD suppliers. The reason for the delay was regulatory questions from China's anti-trust authority, which had recently approved Seagate's acquisition of Samsung's HDD business.

The consolidation has resulted in a secular change in the demand/supply dynamics of the HDD industry. For a more detailed description of the consolidation and its impact on the two listed suppliers remaining in the industry, Western Digital (NYSE:WDC) and Seagate (NASDAQ:STX) see here.

WDC paid $4.8Bn for Hitachi's HDD supply base, which produces 30m HDD's per quarter.

The current financial position of the two listed players, specifically the enterprise value, stands as follows:

  • Seagate: Mkt Cap $12.7bn, Balance Sheet $0.6bn debt. Enterprise Value $13.3 bn. Capacity after Samsung acquisition (consummated in Jan 2012), 70m HDD's per quarter.
  • Western Digital: Mkt Cap $9.5bn, Balance Sheet $3.9bn cash. Enterprise Value $5.6 bn. This does not incorporate WDC's acquisition of Hitachi; this was approved on March 12th, and the first occasion for investors to observe the reconfigured financials will be on their 3Q 2012 earnings disclosure, released after hours on 26th April. But we know the detail: WDC will issue 35m shares and pay $3.9bn for Hitachi's HDD capacity.

The table below shows the current Enterprise Value the market is imputing for the HDD quarterly capacity. (call this ENT/QTR CAP). The ratio is not meaningful on its own, but highly relevant as a comparative tool for the new listed entities. The underlying capacity is still in flux, given the Thai floods, but depicted below are the capacities of the new business combinations in their stable states, post the Thai flood repair and the Hitachi acquisition.

The final line (WDC-Hitachi) in the table imputes the price WDC paid for Hitachi. $5.3bn or $3.9bn cash and 35m WDC shares (The price announced was $4.9bn, but I am using the current market value of WDC shares). As mentioned above, this will be integrated into their financials for the first time on their forthcoming April 26th Conference Call that reviews their 3Q F12 results.

The result is remarkable. Look at the final column, ENT/QTR CAP, which depicts the current enterprise value, as adjudged by the market, for the underlying quarterly capacity:

ENT/QTR CAP
MKT CAP DEBT/CASH ENT VAL Qtr Capacity Enterprise Value
Enterprise Value per qtr HDD prod
$ HDDs $/HDD price
Seagate 12.75 0.6 13.3516 13,351,600,000 70,000,000 190.7 28.4
Samsung 1,400,000,000 15,000,000 93.3
1,920,000,000 15,000,000 128.0
WDC 9.54148 3.9 5.64148 5,641,480,000 52,000,000 108.5 40.43
58m less 6m toshiba hdds
Hitachi 1.41505 3.9 5,315,050,000 30,000,000 0 177.2
WDC-Hitachi 10.95653 0.4 10.5565 10,556,530,000 82,000,000 128.7 32.5%
Click to enlarge

As can be seen, the purchase price of Hitachi was fair, just 7% below the current ENT/QTR CAP of Seagate.

The final line, WDC-Hitachi shows the new combination, post the acquisition and its purchase price.

It shows the significant discount of WDC-Hitachi, a 32% discount at current prices to Seagate. There is absolutely no reason for this; in fact WDC has a superior historic record of earnings stability.

The market is currently digesting the secular shift in the industry; the consolidation from 5 to 3 players in the last 12 months; the realization that Solid State Drives (SSD's) are not a realistic substitute, given their much higher cost, when one factors in their cost per gigabyte of storage.

Both WDC and STX have had a good run in the last three months, but the out performance of STX has led to this glaring discrepancy in valuation. I believe this is because both players are now incredible cash generators in the new HDD paradigm, and Seagate has disclosed its buyback plans post Samsung, whereas WDC has yet to do so, post Hitachi.

Chart forWestern Digital Corp. (<a href=

The market has not acknowledged is the glaring discount of WDC to STX, an anomaly which will promptly be rectified after WDC's earnings and conference call scheduled for after the market close on the 26th April

Disclosure: I am long WDC, and await their imminent announcement of their cash flow intentions. This will rapidly lead to a closing of the above valuation disparity.