WESTERN DIGITAL CORP WDC
October 26, 2020 - 6:16pm EST by
jstavh
2020 2021
Price: 38.00 EPS 0 0
Shares Out. (in M): 304 P/E 0 0
Market Cap (in $M): 11,600 P/FCF 0 0
Net Debt (in $M): 6,600 EBIT 0 0
TEV ($): 18,200 TEV/EBIT 0 0

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Description

Opportunity: Western Digital (WDC) is an overlooked, misunderstood large data storage company, which is transitioning from cyclical to secular growth on a very long runway. This growth is being created from cloud and data storage, the video game console cycle and Esports, and everything else tech-related that gets people going nowadays, including as 5G, Internet of Things, etc. At the same time, either of WDC’s two product segments is worth roughly the company’s entire enterprise value (EV), and the new CEO David Goeckeler (as of 3/9/20) is reorganizing the company to highlight this huge discount. He is incentivized by tens of millions in stock performance: just his transition equity PSUs could be worth $21M-32M, but these are currently worth $0 unless he brings the stock up. WDC’s turnaround is already showing promise: for example, Goeckeler in ~6 months has completely turned around its enterprise solid-state drives (SSD) portfolio, launching great products and taking significant market share (last quarter, these revenues nearly +70% sequentially). Two years ago, FY18 earnings were estimated at $12/share and came in at almost $15/share with investors hoping for $15/share in FCF two years later. The current stock price is $36-40/share, which is less than 3x those earnings and FCF projections. This stock could easily return to pre-COVID levels of ~$65-70/share (~+78%) or back to $100+/share (~+163%+) is not unreasonable. Additionally, an investor famous for spotting unique stock opportunities has bought a meaningful stake.

Very Cheap, Cash Generative Assets: At $38/share midpoint, the company has a market cap of $11.6B. With net debt of ~$6.6B (~$3.0B in cash), EV is ~$18.2B. WDC has three end markets that can be viewed by two product categories, hard disk drives (HDD) and flash-based businesses, where each product could be worth the whole EV. Mgmt. recognizes this and is reorganizing the business into two separate business units with a GM for each. If you use the same valuation for Seagate’s (STX) HDD business (given duopoly with each having ~40-45% market share), then WDC’s HDD is worth roughly the EV. On the other hand, there are three ways to see that WDC’s flash memory business is worth the EV: 1) JV with Kioxia, formerly Toshiba’s flash memory business was suppose to IPO for $16B, with a valuation as high as $20B, 2) similar valuation comparison to MU as previously done with STX, and 3) the current EV is roughly the price WDC paid for SanDisk in 2016 (and recently Intel is trying to sell its NAND flash business to SK Hynix). Furthermore, before the SanDisk acquisition, WDC historically ran a significant net cash position, in the billions. The company seems adamant on returning to this level: WDC has been paying down its large debt balance since then at a rate of ~$1-2B per year ($17.0B in FY16 vs. $9.6B in FY20), and the company recently suspended its dividend in order to accelerate debt payments. Hence, WDC’s EV is shrinking while its businesses are growing. In FY08 and FY09, WDC generated FCF of $784M and $796M, respectively.

Secular Growth or Beginning of an Up Cycle, Does Not Matter: Up cycles are getting longer and down cycles are getting shorter over the long-term and earnings are increasing through these cycles. WDC’s past few quarterly results showed very high growth (overall growth in F4Q20 was +18% y/y and F3Q20 was +14%) while outlook next quarter is weaker, showing a decline (-6% y/y at the midpoint). Mgmt. believes this is a “digestion period” after high demand, but the market does not believe them and is pricing in another down cycle after coming out of a very painful one. Mgmt.’s explanation makes sense with cloud demand very high during the peak of the pandemic. Also, COVID costs, which are non-recurring, and product transitions are weighing down the stock; however, they are short-term with the latter bringing down margins in the near-term but positioning the company favorably over the long-term. For instance, WDC began shipping its flash solutions for the upcoming new game console launches this past quarter. Supply and demand is balanced and may lean tight. Over the next decade, analysts expect annual growth of 35% and 14% per year on average for NAND flash memory devices and HDD, respectively. This has been represented in memory prices, which have stabilized: they are actually slightly up over the past 12 months when they bottomed in 2019. 

Mgmt. Aligned and Incentivized: David Goeckeler took over as CEO on 3/9/20 and is incentivized by tens of millions in stock performance: just his transition equity PSUs could be worth $21M-32M, but these are currently worth $0 unless he brings the stock up. If he stayed at Cisco (CSCO), then he would have been entitled to these payments. To raise WDC’s stock, Goeckeler is reorganizing the company to highlight this huge discount. Prior to WDC, he was considered the “wingman” of Chuck Robbins of CSCO, where Goeckeler was in charge of ~$34B in revenues. Over roughly 8 years when he had a more managerial role, CSCO stock went from mid teens to mid 50’s (~+250%) and earnings increased from $6.5B in FY11 to $11.6B in FY19 (~+$5.1B or ~+78%). Goeckeler was credited with transitioning CSCO to a software and recurring revenue-based model and returning the business to share-gaining growth. To reiterate, WDC’s turnaround is already showing promise: for example, in ~6 months he has completely turned around its enterprise SSD portfolio, launching great products and taking significant market share (last quarter, these revenues nearly +70% sequentially).

Interesting Shareholder: According to filings, Michael Burry’s 6th largest position is call options on WDC. If you remove his largest position, which is >5x larger than his second largest position, then his WDC call options are ~6% of his portfolio. Burry is adept at spotting stocks where change is afoot and is a value investor who is unafraid of picking stocks that turn into growth opportunities. A few quarters ago, Burry made a similar play with Maxar Technologies (MAXR), which has more than doubled.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Main catalysts are WDC selling or spinning off one of its product segments, peers selling their flash memory business or IPO'ing, continued execution around turnaround (earnings), growth or up cycle continues, supply and demand stay roughly in balance or demand outstrips supply, and sheer value. 

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