BTIG Likes Western Digital's Purchase Of SanDisk; Initiates At Buy, $55 Target

BTIG started Western Digital Corp WDC with a Buy rating and $55 price target following its acquisition of SanDisk Corporation SNDK.

Implications Of The Acquisition

From the acquisition of SanDisk, Western Digital could offset the negative impact of flash chips on its hard drives and its solid-state drive (SSD) business will get a boost from SanDisk's market-leading flash assets. In 2015, Western Digital and SanDisk had generated combined revenue of about $20 billion.

Related Link: Western Digital Closes $1.875 Billion Senior Secured Notes

"We like the acquisition of Sandisk because of the long-run strategic benefits of having captive flash and because we believe the synergies are real and worth the execution risk," analyst Edward Parker wrote in a note.

Parker noted that the market underrates the cost leadership of SanDisk and the "unique" deal is about combining SanDisk's superior cost structure with Western Digital/HGST's enterprise acumen in order to focus entirely on enterprise and cloud markets.

"[F]or any acquisition to work, it has to be about the combination of the two assets. We want to be clear—this acquisition is about enterprise and cloud markets, which from a business model perspective are healthier and more stable end markets than servicing the titans of consumer electronics. What happens with PCs, laptops, and phones is of secondary importance, in our view," Parker elaborated.

Well-Timed Merger

Furthermore, the analyst said the merger is well timed, as WDC is acquiring a "secular growth story at cyclically depressed valuation."

"The issue from Western Digital/HGST's perspective is about flash supply. WD's main supplier of flash is Intel Corporation INTC and in this relationship they are essentially a price taker." The merger enables Western Digital to vertically integrate into NAND, securing long-term access to solid state technology at lower cost.

"Roughly speaking, the ~$15 billion purchase price net of cash is close to the replacement cost of the value of Sandisk's equipment," Parker highlighted.

Distribution Synergies Through The Acquisition

Further, the acquisition offers significant distribution synergies as both firms have "redundant channels and customers" both in enterprise and retail that could be consolidated. On the R&D front, the analyst noted that Western Digital "has a $1 billion SSD business so there is significant overlap potential for synergy."

Western Digital said it expects to achieve full annual run-rate synergies of $500 million in 18 months post the consummation of the deal, which is expected to be EPS accretive on a non-GAAP basis within one year of closing.

Looking Forward

Although Parker acknowledges high integration risks to the acquisition, he feels the upside potential is attractive.

"While we argue that Sandisk's cost leadership at some point will separate the wheat from the chaff, there is significant concern about the demand environment and what it could mean for near-term earnings numbers," Parker highlighted.

However, the analyst said sees see enough "value creation" to justify the risk.

Related Link: Longbow Makes A Cut: Western Digital Faces Multiple Headwinds, Declining HDD Trends, Is Not A Buy

According to TipRanks, Parker has a success rate of 58 percent with an average return per recommendation of +11.3 percent. The analyst is ranked 500 out of 3,906 analysts.

In October 2015, Western Digital agreed to buy SanDisk for about $19 billion, or $86.50 a share, in a cash and stock deal. In March 2016, shareholders of both companies have approved the acquisition, which is expected to close in the second quarter of 2016.

At time of writing, shares of Western Digital were up 1.68 percent at $44.04, and SanDisk gained 0.29 percent to $75.89.