This is about as perfect a setup as we can get. Two tech companies merging with combined synergies of up to $1.1 billion and each having a very high percentage of market share already. Add in the fact that the surviving entity has seen their shares decline 50% over the last 12 months and that is the perfect time to enter the trade.
WDC - Western Digital Company Profile
Western Digital develops, manufactures and sells data storage devices that enable consumers, businesses, governments and other organizations to create, manage, experience and preserve digital content worldwide. They produce hard drives for consumer PCs and enterprise servers. They produce solid-state drives (SSDs) that contain flash memory and operate at many times the speed of a conventional mechanical disk drive. They produce direct attach storage solutions for private and public clouds with storage per device of up to 24 TB.
Several months ago Western Digital agreed to buy flash memory maker SanDisk for roughly $80 per share or $16 billion. SanDisk has a revolutionary new memory technology that is due to hit the market soon and is considerable faster than existing flash memory. Western will be able to incorporate this super fast flash into its products and move well ahead of competitor Seagate Technology (STX). Seagate purchased competitor Samsung and Western Digital purchased Hitachi over the last several years. That leaves Seagate and Western Digital as the only major disk storage manufacturers in the world.
The shareholders of WDC (90%) and SNDK (98%) recently approved the merger and the U.S. and EU regulatory agencies have given approval. China is the only major country still working on their approval process. The merger is expected to complete in Q2. However, China could elect to drag out the approval process in order to extract concessions from the combined companies. They have done this before as in the Hitachi acquisition. Western is expected to derive $500 million in synergies from the SanDisk acquisition in the first two years and another $500 million by 2020. Institutional Shareholder Services, a company that advises investment firms, believes there will be up to $1.1 billion in cost synergies. That is a huge plus for WDC.
When Western Digital bought Hitachi in 2012, China approved the transaction but required WDC to maintain manufacturing and sales separate from WDC manufacturing and sales for 2 years. At the end of that period China tried to impose new restrictions and after a long battle they finally relented in December. Western will finally be able to fully integrate the Hitachi acquisition into Western's manufacturing process. That is expected to provide them with another $500 million in synergies over the next two years.
As a result of the SanDisk merger, Western Digital will have an opening to spread out in the flash storage market. SanDisk will be able to leverage Western's decades of market share in the hard drive market to expand on its flash storage into laptops, notebooks, tablets, PCs, etc. This is a win-win for both companies.
Western Digital shares have bounced around between $40-$50 for the last two months as the acquisition headlines played out in the market. Western's partner, China's Unisplendor, pulled out of the deal. They had planned on investing $3.78 billion in Western Digital and western was going to use that money to help finance the $19 billion SanDisk acquisition. When Unisplendor pulled out, Western negotiated a new deal for $15.8 billion with SanDisk and the deal went forward. That period saw shares drop to $40. Western announced debt deals last week to raise $17 billion in the market and the merger is looking very good. Now that all the hysteria is over the shares should begin to move higher as we get closer to completion. Shares gained $3 on Friday as the debt sale and shareholder approvals were announced.
Analysts are upgrading their ratings with Needham upgrading to strong buy and Citigroup to a buy. Needham has a price target of $90.
I am recommending we take a position ahead of the completion with the understanding that China could drag out the approval date. I gave serious consideration to using a 2018 LEAP but decided to go with 2017 instead. We can always roll forward late in 2016.
Earnings are April 28th and we will hold over the announcement.
Buy Jan 2017 $55 LEAP Call, currently $5.05, no initial stop loss.
Sell short Jan 2017 $35 LEAP Put, currently $2.75, no initial stop loss.
Net debit $2.30.
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