Shares of hard disk drive and NAND flash manufacturer Western Digital (WDC +0.93%) plunged today, down 9.3% in today's trading.
Western Digital's end markets in data storage are in a terrible downturn despite the artificial intelligence revolution, which is apparently benefiting the dynamic random access memory (DRAM) industry much more than NAND flash and HDD storage. But investors had held out hope that a merger between Western Digital's NAND business and NAND flash peer Kioxia would potentially lead to a bigger and stronger company while also unlocking value.
However, it appears that the deal, in the works for two years, has been scuttled. Adding insult to injury, Western Digital's HDD peer Seagate delivered worse-than-expected earnings today, increasing the pessimism for the sector.
NASDAQ: WDC
Key Data Points
The giant merger is dead, and a competitor killed it
Western Digital informed Kioxia that it would end merger talks today after Kioxia investor and competitor memory giant SK Hynix declined to give its approval. SK Hynix, which owns a stake in Kioxia, claimed as its justification that the proposed deal undervalued its stake in Kioxia. On its own earnings call earlier this morning, the company's CFO said SK Hynix "is not agreeing to the deal at this time in light of the overall impact on the value of the company's investment in Kioxia."
The NAND flash industry only has five major players outside of China, with Kioxia number two and Western Digital number four in terms of market share. The merger would have created the No. 1 NAND flash company, slightly exceeding market leader Samsung. Meanwhile, SK Hynix was the No. 3 player as of June, according to research firm Trendforce.
So, it's a bit strange that SK Hynix would have veto power over the deal, given that it's also a large competitor. However, SK Hynix acquired its stake in Kioxia as part of a Bain-led consortium, which acquired a majority stake in the memory manufacturer from Toshiba in 2018.
Western Digital and Kioxia operate a joint venture as part of their NAND flash business, and neither has a DRAM business. So, a deal between the two seemed to be intuitive and likely. However, given the awful bear market in NAND flash, with basically all players now losing lots of money in the space, valuations were likely to be a roadblock in agreeing to terms.
In any case, the deal would arguably have led to a stronger company. But now, Western Digital will have to fend for itself. That's a tough task since the NAND business is so bad that Western Digital actually inked a negative gross margin for that segment last quarter.
That leaves the company dependent on its more consistent HDD business. However, Seagate reported earnings today, with revenue missing analyst estimates and worse-than-feared guidance for the current quarter.
Western Digital is a no-touch
Things are now even more complicated for Western Digital, as it has about $5 billion in net debt as of the June quarter. And while highly cyclical memory companies are usually great buys when things look bleak, Western Digital's debt load complicates its ability to make it to the next up-cycle while investing in the latest technology.
Western Digital was always a difficult turnaround story, especially in light of stronger peers that also produce DRAM. Yet, the picture gets even darker with the Kioxia merger now scuttled.
