Professional Documents
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INVESTMENT GROUP
5/20/2011
Consumer Goods
$23.06-41.87
WDC
1.31
236 M (Diluted)
4.73 M
$8.85 B
Current Price
Dividend
Dividend Yield
$36.38
N/A
N/A
$40.24
$51.40
$43.59
$36.38
Summary Financials
Revenue
Net Income
Operating Cash Flow
2010A
$9.85 B
$1.38 B
$1.52 B
BUSINESS OVERVIEW
Founded in 1970 in Irvine ,CA, Western Digital Corporation has grown to become the largest manufacturer of
computer hard disk drives (HDDs) in the world. HDDs are used in desktop computers, notebook computers,
enterprise applications, as well as network storage. Hard disk drives use rotating magnetic disks to store data
fast and efficiently. HDDs are types of non-volatile storage which mean that when a power source is removed
from the drive the data still remains. Western Digital (WD) HDDs currently come in 3.5-inch and 2.5-inch drives
Covering Analyst: David Douglas
Email: ddouglas@uoregon.edu
The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational.
Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be.
Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIGs portfolio. In
addition, members of UOIG may attempt to obtain employment positions with firms held in UOIGs portfolio.
with capacities ranging from 80 gigabytes to 2 terabytes with speeds of up to 10,000 revolutions per minute.
WD products are sold to original equipment manufacturers (OEMs), original design manufacturers, distributors,
resellers, and retailers. WD sells to three main market segments; Desktop PC Market, Mobile PC Market, and
Enterprise Market.
OEMs
Distributors
Retailers
% Revenue
51%
31%
18%
Americas
Europe
Asia
% Revenue
24%
23%
53%
Desktop PC Market
The desktop PC market includes personal computers that are used for regular use in one location.
Desktop computers use 2.5-inch or 3.5-inch drives to store the computers operating system,
application software, and data used by applications. These computers are purchased for personal
and business purposes. WD expects this market to grow because of increasing use of the internet
to download data, growth of computer use in emerging markets, and an increased need for larger
amounts of storage on desktop computers.
Mobile PC Market
The mobile PC market includes notebook and netbook computers. Mobile PCs are used for both personal and
business use. Just like the desktop market, mobile PCs use hard drives to store the
computers operating system, application software, and application data. WD believes there
will be strong growth in this market fueled by the increased use of portable computers and
the increased use of the internet to download and store content. 2.5-inch drives are the
primary choice of hard drive for mobile PCs.
Enterprise Market
The enterprise market includes drives used for business workstations, network storage, networkcommunications, and video surveillance. These drives are used primarily for large scale business storage. WD
produces both 2.5-inch and 3.5-inch drives for this market. Enterprise class drives are faster, more scalable, and
just as reliable as regular class drives. Currently there is strong demand for 2.5 inch enterprise class drives for
use in business blade servers. Cloud computing also uses enterprise class drives to store data uploaded to the
cloud. This is one of the primary drivers of this market. Just recently WD started
making SATA interface drives for the enterprise market.
Serial Advanced Technology Attachment (SATA)
SATA interfaces use high speed serial cable for data transfer. The advantages
of SATA technology include faster data transfer because of higher signaling
rates and more efficient transfer through I/O queuing protocol. WD SATA interface drives cost less,
offer higher capacities, and maintain reliability, all with high scalability and performance.
Western Digital products are broken up among these three markets. The types of drives they sell are
external drives, internal drives, solid state drives, and an other segment.
External
External hard drives are the easiest option to add storage or to take data on the go. These drives are easily
plugged into a computer and add additional storage space. These drives hold anywhere from
250GB to 6TB of space. WDs two most popular external drives are the Passport and MyBook.
The Passport is a portable drive that can be directly plugged in to a computer that needs no
power source. The MyBook is a larger drive that is most often used as additional storage for a
desktop. These are the most popular branded products WD sells.
Internal
Internal hard drives are the most popular product WD sells. They are sold primarily to OEMs who install them
inside desktop and notebook computers. These drives come in both 2.5 and 3.5-inch sizes and can store up to
2TB of data with speeds up to 10,000 RPM. WD also sells enterprise class internal
drives that are more expensive but also the most efficient and high performing meant
for large scale data storage. These drives are used in company servers, networking
centers, work stations, and other large scale computer systems. Internal hard drives are
the most cost effective and reliable way to store data and remain the most popular
amongst both computer manufacturers and large corporations.
Solid State Drives
Solid State Drives are internal drives that utilize flash memory to store data without needing a
power source. SSDs have no moving parts and are therefore more reliable than traditional drives.
In 2009 WD released their first SSD and plan to release a second at the end of 2011. SSDs are
much more expensive per unit of memory than traditional internal drives. WD continues to work
to develop this product segment as it is becoming more and more popular amongst computer
manufacturers and consumers.
Other
WD has a range of other branded products. These include networking and home entertainment products. Home
entertainment products include media players, media drives, and DVR
expanders. These allow for multimedia to be stored and played through a home
entertainment system. Networking products allow files to be shared by
computers on a single network. These drives are a small portion of WD sales but
are expected to become more popular as more people store digital media content on devices of this type.
Komag Inc, is the leading manufacturer of magnetic thin-film disks that are used in hard disk drives. These are
one of the most important components in drives that allow data to be read and written. This
acquisition has helped WD vertically integrate and add one of the main components of its
products to their own supply chain. This has also allowed them to cut the costs of their drives
and given them the ability to offer drives at a lower cost than their competition.
Silicon Systems is a leading manufacturer of solid state drives. They focus primarily in solid state
drives meant for use in embedded systems. Embedded systems are those used by existing
computing systems that read and transmit data in order to improve efficiency of a product. This
acquisition allowed WD to enter the solid state drive market in which they had no product
offering.
Hoya Magnetics is a manufacturer of magnetic media. Magnetic media is a key component of a hard drive that
allows data to be stored. Their operations are primarily in Asia where most of WDs
manufacturing takes place. Like Komag Inc, this acquisition has allowed WD to add
another key component of their products to their own supply chain. This vertical
integration is important to lowering costs and getting higher margins on their products.
Hitachi Global Storage Technologies is a producer of computer hard disk drives. They currently have HDDs,
SSDs, and a significant presence in the enterprise drive market. This acquisition will
allow WD to increase their market share and therefore take advantage of economies
of scale as well as increase their product mix and market share in areas of the
industry they do not have a significant presence.
PORTFOLIO HISTORY
Portfolio
DADCO
Tall Firs
Svigals
Date
10/1/2010
10/19/2010
10/8/2010
Price
$ 28.19
$ 29.57
$ 28.91
Shares
100
575
73
Total
$ 2,819.00
$17,002.75
$ 2,110.43
Current Price
$
36.38
$
36.38
$
36.38
Current Value
$ 3,638.00
$ 20,918.50
$ 2,655.74
Gain
$ 819.00
$ 3,915.75
$ 545.31
Return
29.05%
23.03%
25.83%
Elan Gibb presented WDC to the group on 10/01/2010. WDC was trading at $28.20 on the date he presented.
Using a comparables and discounted cash flow analysis Elan came up with an implied price of $34.67, a 22.94%
undervaluation. WDC was voted a buy for all portfolios and has been one of the top performers since its
purchase. The announcement of the acquisition of Hitachi Global Storage Technologies has been the key driver
of the price accounting for about 22% of the total return.
RECENT NEWS
Western Digital takes a hit in Q3, still out-ships Seagate- techconnect.com 4/21/2011
For third quarter 2011 Western Digital reported revenue of $2.25 billion which met expectations but was down
from $2.64 billion in Q3 last year. EPS was $.62, down from $1.71 a year ago. Lower sales were caused partly by
a chipset problems and the earthquake in Japan.
Samsung Sells Hard Disk Drive Business to Seagate - Wall Street Journal 4/19/2011
Seagate has announced that it will be purchasing the hard disk drive segment of Samsung Electronics Co.
Seagate will pay $1.375 billion in cash and stock. Samsung is the largest manufacturer of flash memory chips and
this will give Seagate a significant presence in the SSD market. This deal will give Seagate about a 40% market
share in the hard drive industry.
Hitachi Rises on 4.3 Billion Sale of Hard-Drive Unit to Western Digital- Bloomberg 3/7/2011
Western Digital will be purchasing the hard drive manufacturing unit of Hitachi, Ltd. for $4.3 billion. For
Western Digital this will help boost market share in the hard drive manufacturing industry and challenge rival
Seagate in the enterprise market. Western Digital stock was up sixteen percent upon the news.
INDUSTRY
WD operates in the computer storage and peripherals industry. This is an industry characterized by
consolidation, competition, and downward price pressure. Consolidation has been a key trend over the last five
years. WDs largest competitor Seagate Technologies purchased hard drive manufacturer Maxtor and EMC has
acquired many smaller drive manufacturers. Along with WDs
acquisition of Hitachi, Seagate will also be acquiring the hard drive
unit of Samsung. WD, Seagate, and Toshiba are the only large scale
manufacturers left. Over 98% of hard drive industry sales are done
by these three companies. All of these companies have large
amounts of cash on hand and are expected to increase acquisitions
of suppliers to help vertically integrate their business.
Almost all major manufacturing in this industry is done abroad. WD
does most of their manufacturing in Malaysia and Thailand. Many
hard drive components are supplied from Japan. The earthquake in Japan has had a large effect on
manufacturers. Not only is demand expected to fall in this region but they are also supply constrained. WD
expects that they will not be able to meet demand in the first quarter of 2012 because they will not have access
to enough materials as Japan rebuilds.
Most hard drives in the industry are priced similarly so it is important for manufacturers to keep costs low to
compete with the other companies. As computers become less expensive there will be price pressure from
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computer makers to get HDDs at a low price. This downward price pressure makes it very important for
companies to continually be finding ways to lower costs.
Major growth is expected to come in enterprise class storage products. IT departments are becoming more
important to businesses and have to hold more and more data. One of the largest areas of growth will be in
cloud computing where data is saved in a location other than the
computer being used. Cloud computing requires large amounts
of storage as all the data must be stored on a hard drive. As
cloud computing becomes more popular low priced, high speed
enterprise drives are expected to experience large growth.
Expectations for the next five years see enterprise storage
systems growing at rates as high as 25%. More and more
companies are also moving towards storing data digitally instead
of paper and companies need enterprise class storage devices so
store all that data.
Growth is also expected in emerging economies. As prices of
computers have fallen the demand for computers in emerging economies, especially in Asia has risen. As prices
of computers are expected to continue to fall in price it is expected that demand for these products will
continue to rise. There have also been increases in demand in Latin American countries for computers. As the
internet is becoming more easily accessible throughout the globe more storage space will be necessary to
download content.
There is also an industry trend away from traditional hard disk drives towards flash based solid state drives.
Solid state drives have no moving parts so they are much more reliable than traditional hard drives. Some
expectations have flash memory completely replacing traditional magnetic drives within the next five to six
years. Flash memory though is still very expensive compared to magnetic drives and it could take many more
years before this form of memory becomes affordable for regular use.
S.W.O.T. ANALYSIS
Strengths
Weaknesses
Opportunities
Threats
CATALYSTS
Upside
Downside
COMPARABLES ANALYSIS
Comparable companies were chosen based on how close their products were to that of Western Digital as well
as those who face similar risk. I chose to use Seagate Technologies, Micron Technologies, and SMART Modular
Technologies. The comparables analysis was done assuming that Western Digital and HGST are now one
company. The reason for this is that WDs stock price is up over 25% upon the news that they would be
acquiring HGST. I believe the market is already pricing the stock based on the revenues WD will create after the
acquisition. Current revenues are not an accurate reflection of the price WD is currently trading at.
The multiples used to calculate EV/Revenue, EV/Gross Profit, EV/EBITDA, and EV/Net Income. EV/Net Income
was thrown out for the fact companies could make net income seem better than it may be. EV/EBITDA was
weighted higher as it was the only bottom line multiple.
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to the diluted share count to reflect the issuing of stock to Hitachi. The assumptions use debt at the current rate
today as the long term debt has been taken into consideration and paid off in the working capital model.
Revenue
The revenue model splits Western Digital up into the WD segment and the Hitachi segment. Revenues are then
projected separately. I grew the companies as if they were the same but projected the two companies
separately because product mixes are different. Revenue is then broken up by geographical region. Growth in
Asia is expected to be the largest, the Americas the second largest, and the European market is expected to
become a very small portion of revenue. It is expected that Western Digital will grow at a faster rate than the
Hitachi segment as they have more popular products and the addition of enterprise class drives should fuel
growth in the Americas. Hitachi will grow at a slower rate at first but towards the end will grow faster.
Costs of Revenue
The Hitachi acquisition will allow WDC to take better advantage of economies of scale and keep costs down.
Management believes that by 2016 they can achieve gross margins of 24%. Costs should also decrease as WDC
becomes more vertically integrated and acquires current suppliers. Cost of revenue will fall until 2016, level
out, and slowly rise to 77% in the terminal year. This rise is due to lower margin drives such as solid states
becoming a larger portion of sales.
Sales, General, and Administrative
SG&A is expected to stay relatively constant as a percentage of revenue. It is trended up over the course of the
DCF to the historical average.
Research and Development
Research and development is the key to WDC staying competitive in their market. They must continue to
innovate and introduce new products to meet the changing demands of OEMs. Management expects R&D to
increase as a percentage of revenue in the future as they work to expand into the enterprise and solid state
markets.
Acquisitions
Acquisitions allow WDC to stay competitive in the marketplace and keep costs down. In 2012 the acquisition of
Hitachi is expected to be complete. It is expected that acquisitions will continue to be made and are projected
slightly lower than the historical average. Acquisitions are expected to be 2% of revenue following the last
payment on the Hitachi acquisition.
Interest Expense
The Hitachi acquisition will be financed through a $2 billion loan paid in full over the next five years. The
interest payments on this loan are reflected in years 2012-2016. Interest expense is expected to be .25%,
slightly higher than the historical average, as WDC also plans to add a 500 million dollar line of credit.
Tax Rate
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Taxes for WDC have been historically low because of tax incentives and foreign tax holidays. The holidays and
incentives are expected to expire over the next ten years. A weighted average of corporate tax rates in areas of
Europe, Asia, and the Americas was used to determine the tax rate in the terminal year. The rate is slowly
trended up in the beginning then starts to increase to the weighted average rate in the terminal year.
Depreciation and Amortization
Depreciation and amortization has remained relatively constant as a percentage of revenue but have been
trended up because of capital expenditures and acquisitions.
Capital Expenditures
Capital Expenditures are projected to increase then decrease to 7.5% in the terminal year. Most expansion and
major changes will be made through strategic acquisitions so major increases in capital expenditures are
accounted for in the acquisitions section.
Net Working Capital
WDC is currently holding a high amount of cash. This is expected to decrease considerably over the course of
the DCF as the Hitachi loan is repaid and new acquisitions are made using cash. Cash and equivalents are
trended down with acquisitions and loan repayments that are expected to be made using cash. Inventories and
accounts receivable are trended up as acquisitions are made and controlling inventories will become more
difficult.
Beta
Five different betas were calculated, a five year monthly, two year bi-monthly, one year weekly, Hamada, and
Vasicek. The Hamada and Vasicek I felt were too high. The peer group used on average had much higher betas
and had much more risk than WDC. The one year weekly was much lower than it has been in the past so I felt
the average of the five year monthly and two year bi-weekly were the most reflective of WDC moving forward
which gave a beta of 1.31.
5 Year Monthly
Two Year Bi-Monthly
One Year Weekly
Hamada
Vasicek
1.30
1.32
1.17
1.70
1.65
Cost of Debt
Cost of Debt was calculated using the preliminary terms of the Hitachi loan with Bank of America. The interest
rate on the loan will be determined using the highest rate of four options. Currently the highest of these options
is the Bank of America prime rate which is 3.25%. On top of this there will be a 1.5% margin and a .25%
commitment rate. This is a conservative estimate and there is a good chance this rate will be lower.
Weighted Average Cost of Capital (WACC)
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A single WACC could not used to be discount the entire DCF because the capital structure of WDC will change
over the course of the DCF. The Hitachi loan will make WDC 28% debt compared to 2% debt now. Since the
loan will be paid off over five years, the percent debt will continue to decrease over those five years. This will
also cause the cost of equity to change. With more debt WD will have a higher beta over those five years. A
new beta was also calculated for each year to take into consideration taxes and capital structure. A new cost of
equity, capital structure, and tax rate was used to calculate a different WACC for each year.
RECOMMENDATION
Western Digital Corporation is currently held in the DADCO, Tall Firs, and Svigals portfolios. Since it was
purchased it has been one of the top performing stocks for the group and has already exceeded the implied
price that was presented in October. The announcement of the acquisition of Hitachi Global Storage
Technologies has been the key driver of the price of the stock. This acquisition will allow WD to enter the
enterprise storage market where they currently lack products, expand their SSD offerings, and substantially
increase their market share in the HDD market. With strong growth projected in Asia as well as increases in
demand for enterprise class storage in America, WD has the opportunity to take advantage of their acquisition
and grow the company.
Weighting my DCF at 70% and comparables analysis at 30% gave an implied price of $45.02, a 23.75%
undervaluation. Based on the undervaluation, I recommend a HOLD for all portfolios.
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APPENDIX 9 SOURCES
WDC 10K
WDC 10Q
www.westerndigital.com
WDC Investor Relations
Standard & Poors Net Advantage
Business Source Premier
IBIS World
http://www.bretwhissel.net/amortization/amortize.html
www.taxrates.cc
Google Finance
Yahoo! Finance
Hitachi.com
Seagate.com
Smartm.com
Micron.com
Stockcharts.com
FactSet
Sec.gov
BankofAmerica.com
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