What Is Western Digital Planning With Its $3.8 Billion Investment From Chinese Group?

by Trefis Team
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Western Digital (NASDAQ:WDC) and Chinese state-backed Unisplendour Corporation – a subsidiary of Tsinghua Holdings – signed an agreement at the end of September, with the latter investing $3.8 billion in Western Digital for a 15% equity stake. The newly issued shares cost Unisplendour $92.50 a share, which was more than a 30% premium to the market price at the time. [1] This announcement comes in what has been a slow year for Western Digital. The company reported a 13% year-on-year decline in net revenues to just under $3.2 billion in the most recent quarter. Correspondingly, Western Digital reported a 23% y-o-y decline in the number of units shipped to 48.5 million during the quarter. [2] Similarly, the company reported a 10% annual decline in the total number of shipments in the March quarter to 54.5 million units. Much of the decline has been attributable to weakness in the PC market, a trend which is likely to continue through the end of the year.

We have a $93 price estimate for Western Digital’s stock, which is about 10% higher than the current market price. Its stock price had fallen by about 30% since the beginning of the year before the announcement was made. Subsequently, Western Digital’s stock price has surged by nearly 20% this month.

See Our Full Analysis For Western Digital’s stock

How Tsinghua Holdings Has Been Teaming Up With American Firms

Back in 2013, former NSA contractor Edward Snowden divulged classified data about the U.S. Government spying on computers in mainland China and Hong Kong among other nations. [3] In the aftermath of this, a number of American tech companies witnessed a slowdown in product sales in China, which is typically a highly profitable market for the tech industry. The ‘Snowden Effect’ particularly affected data storage and data management companies, given that the leaked documents led Chinese customers to believe that the U.S. government leveraged the capabilities of tech companies and data storage companies to breach data. Some companies affected at the time included IBM (NYSE:IBM), Cisco (NASDAQ:CSCO), Qualcomm (NASDAQ:QCOM) and EMC (NYSE:EMC). [4] [5] Subsequently, tech companies have made efforts to forge alliances with Chinese companies to gain the trust of the massive Chinese client base. Moreover, top American tech firms collaborating with local Chinese manufacturers get a huge thumbs up from the Chinese government since it helps local companies to transition from cheap white label manufacturers to original design manufacturers. [6]

Initially owned by Tsinghua University, Tsinghua Holdings is now a fully state-owned corporation. It has a very wide array of subsidiaries in China, with businesses across sectors ranging from consumer electronics, energy, manufacture, venture capital, semiconductors, construction and software development. Last year, chip-maker IBM invested $1.5 billion for a 20% stake in Tsinghua Unigroup, which owns two of China’s top-three largest chip designers, Spreadtrum Communications and RDA Microelectronics. [7] Hewlett-Packard (NYSE:HPQ) sold a majority 51% stake of its data-networking division to Tsinghua Holdings for $2.3 billion earlier this year. [8] Back in July, there were reports that the Tsinghua Unigroup was preparing a $23 billion takeover of leading chip maker Micron Technology (NASDAQ:MU) . More recently, Dell (NASDAQ:DELL) announced that it will invest about $125 billion in China in the next five years, and will switch over 40% of its PCs sold in China to a Chinese operating system. [9] The chairman of Tsinghua Holdings, Xu Jinghong, has also expressed interest in partnering with leading American software firms including Facebook (NASDAQ:FB) and Microsoft (NASDAQ:MSFT) in the future. [10]

How Western Digital Fits In Tsinghua’s Horizon

Unisplendour’s $3.8 billion investment for a 15% stake in Western Digital reinforces the idea of a collaboration between the Chinese holding company and an American tech company that is possibly looking to gain back trust in China. Through the investment, Unisplendour gets to nominate a member on Western Digital’s board as long as the investment remains in excess of 10%. Moreover, Unisplendour agreed to a five-year lock-up period on the shares it will own, with this transaction expected to close in the current quarter. Below are a few reasons why Unisplendour’s investment in Western Digital makes sense for both parties.

Healthier Balance Sheet For A Possible Acquisition?

Although Western Digital ended its fiscal 2015 (in June) with a fairly modest set of results, its balance sheet remained healthy, with about $5 billion in cash and about $2 billion in long-term debt. Western Digital’s management indicated that the equity investment by Unisplendour will help facilitate growth and future strategic initiatives. [1] Adding another $3.8 billion to the balance could help the company facilitate a large-scale acquisition.

SanDisk (NASDAQ:SNDK) is one company that could be a potential acquisition target for Western Digital. In recent months, SanDisk has had a few setbacks, ranging from product qualification delays and a possible loss of a major customer. It lost revenues through the first half of the year and its stock price has plummeted by nearly 40% since the beginning of the year. This could provide an opportunity for Western Digital. [11] Moreover, Western Digital has been betting on hard drives for a long time, and has often been reluctant to switch over to the flash storage completely. SanDisk could fill that void perfectly, and the resulting vertical integration with its flash-assets and capabilities could give Western Digital an edge over rival Seagate (NASDAQ:STX) when its comes to flash storage.

HGST Integration

Western Digital acquired Hitachi Global Storage Technologies (HGST), Hitachi’s hard drive business, for $4.5 billion back in 2012. [12] HGST has since become a crucial business within Western Digital, with the company making new technology-based acquisitions under the HGST banner. Western Digital acquired flash storage array maker Skyera for about $200-$500 million in December 2014, SSD manufacturer sTec for $340 million in June 2013 and enterprise flash and SSD storage manufacturer Virident Systems for $685 million in September 2013, all through HGST.

According to regulations laid down by the Chinese Ministry of Commerce (MOFCOM), Western Digital was initially required to wait 24 months before completing the HGST acquisition. In the meantime, HGST would continue to operate as an isolated entity within Western Digital. However, after more than three years and resolving certain non-compliance issues, Western Digital is still waiting for approval from the Chinese authorities. [13] At the end of last year, Western Digital’s management mentioned that they were in advanced talks with the authorities. If the company gets the go ahead to merge the two entities, it could lead to savings of about $400 million a year in operating expenses.

Tsinghua Holdings’ investment in Western Digital could potentially help the firm integrate HGST more quickly. However, Western Digital’s management maintained that the investment by Unisplendour has nothing to do with MOFCOM’s awaited decision regarding HGST. [14] Even if MOFCOM approval wasn’t a key objective behind the investment, it is likely to help going forward. The upcoming earnings call at the end of this month should paint a clearer picture for what lies ahead for Western Digital.

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Notes:
  1. Western Digital Announces Equity Investment By Unisplendour Corporation Limited, Western Digital Press Release, September 2015 [] []
  2. Western Digital Announces Financial Results For Fourth Quarter And Fiscal Year 2015, Western Digital Press Release, July 2015 []
  3. Edward Snowden: US government has been hacking Hong Kong and China for years, South China Morning Post, June 2013 []
  4. In China, U.S. tech firms weigh ‘Snowden Effect’, Reuters, January 2014 []
  5. Secret Contract Tied NSA And Security Industry Pioneer, Reuters, December 2013 []
  6. U.S. Tech Companies Cozy Up to China, Wall Street Journal, September 2015 []
  7. Intel Invests $1.5 Billion for Stake in Chinese Chip Maker, Wall Street Journal, September 2014 []
  8. HP sells $2.3 billion China unit stake to forge partnership with Tsinghua Unigroup, Reuters, May 2015 []
  9. 40% Of Dell Computers Are Running Linux In China As Open Source Movement Gains Momentum, Tech Node, September 2015 []
  10. China’s Tsinghua Holdings Hopes to Partner with Facebook, Microsoft, Wall Street Journal, August 2015 []
  11. Is SanDisk becoming an acquisition target as the market consolidates?, The Register, September 2015 []
  12. WD® Completes Acquisition of Hitachi Global Storage Technologies, Western Digital Press Release, March 2012 []
  13. WD and HGST: We tried to merge our two drive makers, MOFCOM said NO, NO, NO, The Register, December 2014 []
  14. Western Digital sells strangely limited 15 per cent stake to China, The Register, September 2015 []
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