If there is one stock that symbolizes the market’s roller coaster ride, it’s Western Digital (WDC). We began purchasing shares of WDC in December of 2010 and over time, through steady appreciation, it grew into the largest portfolio holding. In January of 2015, Hazelton Capital Partners sold just shy of 1/3 of our shares as the company began to approach its intrinsic value. Over the next 12 months, Western Digital shares began to decline as the cyclical demand for digital storage began to wane. In October, in rapid session, WDC’s management announced a $3.8 billion investment by Unispendor, MOFCOM (China’s Ministry of Commerce) approval of the integration of HGST with Western Digital (Part of the legacy 2012 merger between Hitachi and Western Digital) and acquisition of SanDisk for $19 billion. In short order, WDC created a large cloud of uncertainty over the business and, in turn, the market drove down the stock price over 50% for the year. Uncertainty has not abated as questions remain if the US will allow Unisplendor, a Chinese company, to purchase a large stake in Western Digital. Without the influx of cash from Unisplendor, increased ambiguity will surround the acquisition of SanDisk as WDC will need to leverage its balance sheet and borrow over $18 billion dollars.
Western Digital’s downturn represented over 1/3 of the portfolio overall decline in 2015. Hazelton Capital Partners still believes that WDC is a well-managed company that has a long-term, sustainable competitive edge. Acquiring SanDisk will not only help the company quickly expand its growing SSD (solid-state drive) business but provide WDC with a steady source of NAND flash chips, something Western Digital has been sorely lacking. Management has already outlined that the merger between SanDisk will provide meaningful cost saving that will grow to over $1 billion per year by 2020. That is on top of the approximate $500 million the company will achieve from the final approval for integration by MOFCOM. In the past, Western Digital has been a cash generating machine and we believe, with the acquisition of SanDisk, it will become an even stronger cash generator. In the short-run we believe that some of the company’s value has been impaired but remain confident WDC will be able to both repair and grow its intrinsic value.
This article has been excerpted from a letter to partners of Hazelton Capital Partners.