Western Digital and Kioxia Merger Plans Signal Potential Flash Market Challenge to Samsung, Analyst Says

Benchmark analyst Mark Miller reiterated a Hold rating on Western Digital Corp WDC.

A Friday Bloomberg report suggested that Western Digital hopes to reach an agreement to merge with Kioxia sometime in August. The deal reportedly will be structured as a tax-free spinoff of Western Digital’s flash business, which would merge with Kioxia. 

Western Digital shareholders would own slightly more than 50% of the combined company, headquartered in Japan, and trade on the NASDAQ. With a mid-30% share, the combined flash entity could challenge Samsung for NAND share leadership. 

While the devil will be in the details, due to the current depressed memory market, short-term, the analyst saw a modest upside from such a deal, with most of the value coming from the HDD unit. 

In its 4Q22, Kioxia reported a net loss of $(943) million versus $(610) million in the prior quarter. Sales fell 12% sequentially to $1.8 billion. Kioxia reported a negative margin of 53% in 4Q22 versus a negative 30% in 3Q22. 

Kioxia said its NAND ASPs fell in the high-20% range for 4Q22 versus a low 20% decline in 3Q22. The firm expects demand from PC and smartphone customers will recover in 2H23, but data center demand will remain weak. 

Combined with Western Digital, the firms will likely report a combined loss of $2.67 billion over the current and prior quarters. Western Digital posted a free cash outflow of $527 million in 3Q23 and ended the quarter with $1.59 billion in cash. 

For some time, the analyst believed a spin-out of Western Digital’s flash division made sense. Last quarter, Western Digital reported HDD sales of $1.50 billion, up 3.2% sequentially but down 30% Y/Y. 

For 3Q23, Western Digital also reported HDD non-GAAP gross margins of 24%, up 330 bps sequentially but down 370 bps Y/Y. For its 3Q23, Seagate reported HDD sales of $1.60 million, down 4% sequentially and down 37% Y/Y. 

Seagate’s gross margins for 3Q23 were 17.2%, up 420 bps sequentially but down 1,160 bps Y/Y. Western Digital has a higher product mix for HDDs with fewer consumer drives sold. 

Seagate’s current enterprise value is $17.9 billion versus Western Digital’s enterprise value of $18.4 billion. So, WDC’s HDD unit should have an enterprise value close to Seagate’s. 

The analyst believes most of Western Digital’s $7.37 billion in debt will end up residing on the balance sheet of the combined flash firm. 

After the merger, Miller estimated a combined net debt of the flash entity of $10.7 billion. While investors believe both firms are likely to report losses into 2024, there will be an opportunity for significant synergistic savings. 

The return to profitability for the combined flash venture might accelerate depending on the degree of synergistic savings. 

Based on Micron’s historical valuations, a high single-digit to low double-digit P/E seems appropriate.

Price Action: WDC shares traded lower by 1.40% at $39.11 on the last check Monday.