Eastern Intrigue for Western Digital

There is no bigger poker game or culture clash going on in the business world right now than the tussle between Toshiba and Western Digital (WDC) over their flash memory joint venture.

Toshiba needs to sell its crown jewel chip making unit to recoup some of the losses from the bankrupt Westinghouse nuclear construction business and avoid getting delisted from the Tokyo stock exchange.

Its attempt to do so earlier this year was slowed by Western Digital, which claimed it was entitled to a right of first refusal under the 15-year-old joint venture arrangement. Complicating matters was the fact that Toshiba’s joint venture partner was SanDisk until the latter was acquired by Western Digital last year.

Things got testy after Western asserted its arbitration rights and also sued in U.S. court to block the sale. The U.S. company secured a court order forcing Toshiba to stop barring its employees from joint venture assets, and to continue supplying it with chips and samples under the JV agreement.

Since time is not on loss-stricken Toshiba’s side, these tactics seemed to pay off this month when Toshiba finally agreed to consider an offer from a bidding consortium including SanDisk.  To help his adversary save face, Western Digital’s CEO wrote his Toshiba counterpart an apology letter. ““I understand that the litigation and ongoing disputes have created significant ill will for some within Toshiba. This is regrettable and I am deeply sorry for the feelings this has created,” it read according to a copy obtained by Reuters.

Toshiba’s board convened this week amid talk that it would bless exclusive sale negotiations with Western Digital, but it instead continued to encourage rival bidding groups, one starring key customer Apple (AAPL) and the other Taiwan’s Foxconn. Press leaks from Toshiba insiders cited hostility from key flash memory employees to a deal with Western Digital and hopes of playing off Apple against Western Digital in upcoming haggling.

This is more face-saving Kabuki. The bottom line is that Toshiba is in a hurry to sell and Western’s legal challenges could delay any sale significantly or block it altogether. This is why Toshiba has come back to the negotiating table with Western Digital and why it has a huge incentive to reach a mutually satisfactory accommodation.

This is a high-stakes contest: Toshiba’s flash unit is worth around $18 billion and its chip making technology is crucial to producing flash memory currently in chronically short supply. As a result, Western Digital’s share price has been bouncing around with every news dispatch from To

The truth is that the current joint venture agreement gives Western Digital scale access to Toshiba’s chips but no control over the business, and that this status quo is likely to be maintained no matter who ends up buying out Toshiba. Even the deal proposed by Western Digital would give Japanese partners majority control, while giving it more longer-term leverage by means of a convertible bond investment.

What’s really important here is that Western Digital’s stock has recouped more than half of its 17% pullback in late July and early August, regaining levels that represented a new high back in May. Some of that is clearly tied to the Toshiba soap opera. But I think it will ultimately prove to be more based on  growth and market share gains facilitated by the JV stake as well as the SanDisk acquisition.

That’s what I was counting on a month ago when recommending the January 2018 $75 calls on the day Western Digital’s stock plunged 10%.  Those calls are now up 10%, and I would continue holding them.

I expect Western to rally on the likely near-term resolution of the conflict with Toshiba. And if another bidder were to prevail and the stock got hit as a result, it would represent another buying opportunity.  

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