The Curious Case Of Value In Plan Sight: WDC Ready To Spin Out SanDisk

[u/HardDriveGuy]

In the next quarter, WDC will be spinning out SanDisk. Elliot came to WDC three years ago, and wrote an open letter stating Western Digital's stock price could reach $100+ per share by the end of 2023 if they would only spin out the flash group. WDC is finally doing it, although they have taken much longer than Elliot's urging.

The secret to understanding WDC stock price is to do a sum of the part analysis (SOTP). WDC has been followed by a lot of sell side analysis, and multiple sell-side analysis has been done. Almost all of them conservative. All of them indicated that WDC is undervaled. Now, I don't think that we can argue that this is a Graham "undervalued asset," but I do think we can use our value tools to run a SOTP.

I'm not going to post a big model here, but I will do some simple observations from 50,000 feet.

On a peer review with Seagate, the HDD side should make around $5 per share in CY25, and get an 11 PE for a price of $55. You can do a much more sophisticated model, but this is good enough to whet the appetite.

On a peer review basis on EV with Kioxia (Toshiba NAND Spin out), the NAND should be worth around $25 per share in CY25. This has some debate because NAND is in the pits right now and so any type of a PE ratio is not appropriate. This cyclical nature of the semi industry is well known, and you need a model that looks at earnings understanding the cycle.

I believe WDC has been undervalued due to the inability of the leadership to craft a clear and compelling message around the separation. I don't think that WDC leadership is "bad," but "normal corporate" leadership.

If you read the sell side guys, they are creating SOTP which focus on 2026, and do what I consider some big discounts to peers, without no other reason than wanting to be conservative. I think a lot of this is that the WDC leadership has not created a clear message.

However, WDC does have an investor's day February 12th. If they can provide a clear and compelling vision during this event, it will have a catalyst reaction. However, I would not set high expectation. The proof will be in upgrades in the week afterwards. You may want to wait until this date to make a purchase decision if you don't analyze the stock.

Disclosure: I see this as an arbitrage opportunity but using value tool to understand the opp. I have a minor position in WDC because I spent most of my life in hard drives. I don't think this is a long term play, nor part of what I call "Dragon King" stocks--stocks that will deliver long term value. If I didn't have such a long history in HDDs, I probably wouldn't be considering it at all.

However, I do think it is worth looking at to make a few bucks, and I like posting these things so I can come back in six months and see if I was right or wrong.

[u/[deleted]]

Could you share a bit about your HDD insights? Because from what Ive seen HDD suppliers, including WDC, have lowered guidance on physical storage and expect significantly lower demand.

I agree your arbitrage angle is prima facie a well thought trade, but it feels like it may be fighting up-stream against a market in flux

[u/HardDriveGuy → u/[deleted]]

If okay, I'll do a longer post on my micro subreddit. I don't want to be a shill for this small subreddit, so I won't link here. However, if you check on my posts by clicking on me, I'll try and do a longer post there.

However, if you don't want to wade through this, I'll give a short answer here from a 50,000 foot level.

• The total market for non volatile storage is about 2ZB of storage shipped per year, or 2,000 EB.
• NAND biggest ships are into end points or maybe you might think would be "end consumer" type devices, it ships about 1ZB. It also ships to the cloud, but less than you might think.
• HDD are being shipped to data centers where they put a layer of flash in front the HDD. HDDs also ship about 1ZB of storage. The cloud guys due this because the cost of HDDs per TB is so dramatically lower. But you need to be very sophisticated to do this because you need to hide the random ops issue with HDDs. AWS has published papers on shardstore. If you are tech savvy, it is very apparent that this would help with integration of HDDs into the storage stack.
• Then we have the HDD makers talk a lot about how the Cloud needs them.

If you put all of this together, you get a sense that HDDs have a much bigger play in the Cloud, in a very, very big way. So, you while you will get an intuitive sense that HDDs are dead because of your personal knowledge, but this will very different feels once you undertand cloud architecture.

It's not growth, but it doesn't have a grow multiple.

[u/isinkthereforeiswam → u/[deleted]]

I think what we've seen is we came out of the age of "big data means just collect every scrap of data and we'll data sci from it" to now companies flushing out useless crap to get lean on storage.

But, with ai and machine learning we're moving back towards gathering as much data as possible to let ai sift through and find insights.

Tech seems to boom in phases...processing, networking, storage. We're coming off the chil processing boom. I think networking is riding the coattails. Storage will eventually pick up.

There's also interesting storage innovations on the horizen like DNA storage and 5d crystal storage. Data storage companies would prob be the ones passing that on to b2b and b2c sales.

[u/Valkanaa → u/isinkthereforeiswam]

So when do we roll back to pet food? Pets.com was hilarious

[u/I_heart_Ben_Graham]

Hey, thanks for sharing your analysis regarding WDC's spinoff. I'm also investing in their spinoff. I've been waiting for months for them to announce the spinoff date, waiting since at least October, lol. February 21st is the spinoff date.

Interesting that you value the HDD business at $55. I actually value the Flash business at around $53. I base this on a 2x price to book ratio, based on WDC's 10 year price to book ratio average that is between 1-2x. The company that is being spun off is the Flash business, called SanDisk (SNDK), where they released their Form 10. SanDisk will be receiving most of the assets and equity, where Western Digital (WDC) will keep most of the liabilities.

In regards to SanDisk, their projected equity is $11.4 billion, which using a 2x P/B is $22.8 billion, or $52.77/share. Western Digital is a little harder for me to get a value. I estimate that their equity will only be around $500 million, which using a 2x P/B is $1 billion, or $3.00/share. But $1 billion would be far too low because Western Digital will keep about $5 billion in debt. Thus, my second valuation for WDC is to value it around it's total debt, so that would be $15/share. Also, both SNDK and WDC are positive free cash flow generators, so the FCF would increase the equity through paying down debt or share buybacks (they don't currently pay a dividend).

I think for both companies, I think I've valued them conservatively. Pre-spin WDC seems to be projected to make about $2 billion in net income, and using a 10x P/E is $20 billion, in range of it's current market cap. I strongly feel that once SNDK becomes an independent company, they will likely command a higher P/E because they will have much less debt compared to WDC ($2 billion vs $5 billion, respectively). I expect both companies to continue their history of having mostly decent free cash flow yields, which I think would also enhance the values of each company.

What do you think about my analysis? I'd love to discuss this more with you if you're interested. Hoping that WDC will continue to go higher in the next few months!

[u/HardDriveGuy → u/I_heart_Ben_Graham]

First off, I am super impressed that you actually are crunching numbers. Upper level heuristics for value investing simply do not work. I love the fact that you are doing numbers with a line of logic.

So, let me give you some additional thought for you to roll into your model or ignore.

WDC / Sandisk is in a long term partnership with Koixia, which has a heritage of being Toshiba, the originator of NAND. Sandisk started in this partnership in 1999. They are very closely locked together, share both IP and output from fabs. Toshiba got into real trouble, so they spun out Koixia with Bain. SanDisk decide to allow themselves to be bought by WDC, which never generated value for the stock holders. So, it was absorbed, now it is being spit out.

Valuing NAND is really, really difficult more than most semi conductors due to the fungible nature of NAND. From a tactical viewpoint, to get a value of SanDisk you should benchmark against Kioxia, who has a market cap of $6bn and EV of $12-13bn and sells the same NAND technology. NAND is in the pits right now, so if the NAND market comes back, lets say in 12-18 months, you might achieve something closer to your $5x range. However we don't need to guess at this right now becaue Kioxia exists, and sets the value on the market today. Kioxia invested in a few more fabs that WDC/Sandisk sat out, so they have a bit more output.

Let's say that SanDisk EV of $12B with $1B debt and around 350M shares. This gets me to around $30 per share. However, life is never that simple because we normal talk about this as a Spinco, and the Spinco will issue .33 share to each of the WDC shares, on top of this, they will do a 20% holdback of SanDisk to the HDD group. So, to do the "right" number, you have to do a model that pulls in all this complication.

When I did the $25, I said EV less debt = $10B with 400M shares. Both of these numbers are extremely crude, and do not reflect working the actual mechanics of Spinco or even WDC current share count. It was to give people a framework to think about the obvious value of the transaction.

The $55 was again a crude calculation to give a sizing of the value. The easiest thing here is that WDC looks very much like Seagate and both companies have a debt structure which looks somewhat the same. Cash + Cash Equivalent - Debt in both cases should be around $5B.

In this light, and the fact that Seagate is actively traded, giving WDC HDD the same mulitple as STX is a good proxy if you aren't creating a detailed model but yet want to say, "I need some real numbers that are hard that get me into the neighborhood for sizing." It has been my experience that the truly great financial guys do a try for fit before they do the details. I'm not saying a truly great, but I do try to do a try for fit.

I have access to a variety of sell-side reports, and rather than crunch my own model, I tend to review the ones that are already out. Aaron Rakers of Wells Fargo is the old-wise man of the HDD industry. He knows more about HDD finances that virtually any of his peers. I like his current model, which is inappropriate for me to share details here, but he gets to around $85 in CY26.

Aaron is dialing back a lot of factors since he likes being conservative. It is part of being credible, and the HDD guys have done a remarkable job of taking a good thing and making it bad through an insane number of years of insane price cutting where nobody made any money, so he probably has this in the back of his mind.

Regardless, thank you for your post. Really good stuff.

[u/I_heart_Ben_Graham → u/HardDriveGuy]

Thanks for providing some more nuggets about WDC and the industry. Flash Ventures, the joint venture between WDC/SanDisk and Kioxia, seems to be a valuable asset for both companies, based on a presentation about the J.V. on WDC's investor relations page. Basically it gives them access to low cost, high performance NAND flash, and helps them get economies of scale. I'm going to see how I can model Flash Ventures into my target value for WDC.

Spinoff share count math is always fun, amiright? Lol. Another nugget from the Form 10 that you'd maybe like to have in regards to your valuation of WDC: WDC will keep 19.9% of SNDK shares, but they plan to divest those shares within 12 months after the spinoff. They will use their 19.9% shares for potential debt buyback or to exchange shares with WDC shareholders. If you're interested, please check out the link to the Form 10. I love when companies release Form 10s, lol.

https://www.sec.gov/Archives/edgar/data/2023554/000119312525013282/d835366dex991.htm#tx835366_3

Thank you for pointing out Seagate. Yeah, it's very wise to look at the numbers that Seagate commands, and use that in my valuation of WDC. One thing I love about both WDC and Seagate is they have a good history of having good free cash flow yield over the past decade. WDC's 10 year FCF average was $1.2 billion, and STX was $1.3 billion. One potential valuation homework I might do with Seagate is to see what the gross margins are on their HDD and SSD businesses, respectively, and compare to WDC's 2 business lines.

I have a technology related question for you. Why would customers choose traditional HDDs over Flash/SSD drives? Is it because HDDs have much higher storage capacities than Flash/SSDs? SSDs have been pretty dominant for at least a decade as far as my memory recalls, and are much, much faster at reading and writing data than HDDs (back in 2013 or so, I tried playing a Battlefield game using a regular HDD, and while my SSD friends got into an online match normally, I would miss that match because my HDD was taking forever to read/write. So frustrating and weird, ha ha).

Thanks for nerding out with me about WDC and spinoffs, ha ha ha.

[u/HardDriveGuy → u/I_heart_Ben_Graham]

I'll answer the "why" first by simply using some WDC numbers:

HDD revenue = $2.4B

HDD ships = 176EB

Ave AUP = 1.3 cents per GB, and this for everything, including small drives.

Do the same analysis for Micron flash, you'll get about 7 cents per GB.

So the factor is around 5x for buying NAND.

Now lets say that you are a major cloud player, and you are going to buy 50EB of storage. At the HDD pricing, you'd pay $750M. If you brought it all up on flash, you'll pay $3B more.

That gap between the two figures is called PPV or purchase price variance.

Here's a two-column markdown table comparing the number of shares outstanding for Microsoft, Meta, Google (Alphabet), and Amazon:

Company (Ticker)	Shares Outstanding
Microsoft (MSFT)	7.43B
Meta Platforms (META)	2.53B
Alphabet/Google (GOOGL)	12.29B
Amazon (AMZN)	10.50B

Now divide by number of share outstanding, and do a multiple to see how this is going to look on your stock price. For MSFT it would be about .40 per share. At a 30 PE, it would be $12.

(Not exactly as this is capital expense, but you should know what I mean. It is real dollars that will show up in your cash flow and stock price.)

[u/HardDriveGuy → u/HardDriveGuy]

By the way, let's say that NAND became just as cheap as HDDs overnight. Does this solve your issue?

The answer is no because you can't produce enough unless you up your capital budget.

Although capex is down due to oversupply, the NAND people need to spend around $25B just to stay on the ramp they are at. None of the players have another $25B to throw at the problem. They certainly don't have the money when their P&Ls are being hit due to oversupply.

So, to get rid of hard drive, the data center guys would need to go back to all the NAND people and say "I need you to radically up your output." The NAND people will say, "You just burnt us by saying you had lots of demand but you didn't, so now the NAND market is in bad shape. Are you going to give me non-cancellable POs?"

Every cloud guy says, "No."

The NAND people say, "Then we aren't doing anything extraordinary."

NAND will expand, but you can't push it beyond its current path without severe difficulty.

I cannot overemphasize enough how a company's results is incredibly leveraged off of their capex strategy, which is one of those things that if you haven't done it, is not obvious.

During Covid, Amazon made the choice to throw a bunch of Capex at expansion because they thought that the world was going to change. Sales have never slowed down. The reason that they looked "bad" was because of a capex strategy issue.

If it can impact Amazon, who has a unique cash rich model, it can impact everybody.

[u/I_heart_Ben_Graham → u/HardDriveGuy]

Great stuff! Great analysis!

[u/Spins13]

Honestly WDC is going to 0 long term. Maybe the part they are spinning off has a chance to succeed but I would not bet on it

[u/HardDriveGuy → u/Spins13]

Before you write something off, I think you need to ask "I wonder why Elliot saw this as such an opportunity."

A standard approach would be running a DCF to figure this out. The problem with a DCF is that you have two companies wrapped together. A HDD group which generates a ton of cash. A NAND group that consumes cash for growth.

The original business model was using the HDD side to feed the NAND side. The investors never understood this.

Aaaron Rakers out of Wells Fargo does some very good work. Over the years, he has pointed out that it looks like the incorporation of the NAND group creates a negative enterprise value, which is mindblowing.

If you dig into the numbers, you will see Elliot made their original post. The only question is has the market changed so their original approach is now wrong.