Investors cheered after Western Digital Corp.WDC received a hefty equity investment yesterday. The deal is likely to strengthen the company's balance sheet thereby providing the financial flexibility required for long-term strategic growth initiatives.
In response to the news, Western Digital's shares gained over 14%. Notably, the stock has lost about 36.5% of its value since the beginning of 2015 till the day before yesterday.
The company announced that the Chinese government-backed Tsinghua Unigroup's asset management arm, Unisplendour Corporation Limited (Unis), will buy its newly issued shares at the rate of $92.50 or a total of $3.775 billion. This represents an approximately 34.4% premium over Western Digital's closing price on Tuesday.
Upon successful completion of the deal, Unis will have about 15% equity stake in Western Digital. Per the agreement, "Unis will have the right to nominate one representative to the Western Digital board of directors and will be subject to a five-year position standstill and voting restrictions."
According to Steve Milligan, president and CEO of Western Digital, "The equity investment by Unis will help facilitate [Western Digital's] growth as we look to capitalize on the many opportunities and changes within the global storage industry."
We believe that the deal has come at the right time as the world's leading hard-disk drive (HDD) manufacturer is trying to lower its dependency on PC storage and focus on rapidly growing flash and cloud storage businesses to improve its top-line performance.
Furthermore, although issuing additional shares will be dilutive to the company's near-term earnings, but we view increased investment will help it in pursuing growth in more relevant areas in long run and therefore the dilution makes sense.
Western Digital derives the bulk of its revenues from the sale of HDDs, mainly used by PC manufacturers. The company is the largest U.S. manufacturer of HDDs with 44% market share, closely followed by Seagate Technologies STX with 40% share.
However, the persistent decline in PC sales has hurt Western Digital's HDD shipments, which in turn dented its revenues. The storage solution provider shipped 48.5 million HDDs in fourth-quarter fiscal 2015 down from 63.1 million a year ago and 54.5 million in the third quarter. This resulted in a year-over-year decline of 12.6% in revenues and 18.4% in earnings.
We believe that the cannibalization of PCs by mobile devices have been affecting Western Digital's results. According to independent research firm Gartner Inc. IT , PC shipments in second-quarter 2015 fell 9.5% year over year to 68.4 million units, marking the worst slump since third-quarter 2013. The declining numbers indicate long-term weakness in PC HDDs as well, which remains an overhang on the company's financials.
Adding to its woes, in its Sep 2015 report, Gartner stated that PC shipments (including premium ultramobiles) are expected to fall 7.3% to 291 million units in 2015 primarily due to the lack of device replacement and strong dollar. This compared unfavorably with the July prediction of 4.5% decline as a result of persistent slowdown in purchase in Western Europe, Russia and Japan due to local currency devaluation against the U.S. dollar.
Furthermore, although the company has a strong balance with cash and cash equivalents of $5 billion and long-term debt of $2.16 billion as of Jul 3, 2015, it needs more funds to pursue major acquisitions in flash and cloud storage market.
What's the Scope for Western Digital?
The declining PC industry has affected part suppliers and allied industries as well that mostly depend on PC sales for revenue generation. So Western Digital is focusing on the enterprise side which offers higher-margin business opportunity.
Storage for enterprises is a key growth area in the information technology sector. Anticipating a potential acceleration in cloud deployments backed by exponential growth in cloud data storage, Western Digital has stepped up investment in high-capacity storage devices to support the expansion of cloud infrastructure and applications.
Last year, the company acquired Skyera to boost solid-state drive (SSD) storage capabilities. Moreover, in 2013, it bought Virident Systems to bolster the flash storage business.
Western Digital also believes that higher demand for cloud storage will improve pricing for enterprise-class drives, mainly because of supply constraints. The company expects cloud-based solutions to drive near-term revenue growth.
Western Digital's projections stem from the fact that IDC expects 60% of the 13 Zettabyte (ZB) data produced by 2020 to be stored on the cloud. Apart from this, the focus shift toward enterprise would reduce the company's dependence on the PC market.
Notably, the company reported $244 million in revenues from the Enterprise Solid State Drive segment in the last reported quarter, up from $113 million in the year-ago quarter and $224 million in the previous quarter, primarily supported by higher product adoption.
We believe that the transaction will provide significant liquidity to Western Digital thereby helping it acquire aggressively to build its storage capabilities in fast-growing areas. It won't be a surprise if Western Digital bids for SanDisk Corporation SNDK , as the acquisition will make it the world's largest flash storage solution provider.
In fact, it would be the right time to take over SanDisk, as the shares of this flash drive maker have plunged about 43.8% so far this year.
Currently, Western Digital and SanDisk both carry a Zacks Rank #3 (Hold).