Did Western Digital Make a Good Enough Case for the Leveraged SanDisk Acquisition?

Western Digital Corp. (NYSE: WDC) has laid out its expected savings and other details for its proposed acquisition of SanDisk Corp. (NASDAQ: SNDK). A recent SEC filing showed a pro-forma debt load structure and balance sheet data along with the projected deal synergies. The company also gave some ideas about its long-term expectations for storage Exabyte and revenue growth catalysts.

If investors believe Western Digital at face value, the company expects to deleverage its post-deal balance sheet quickly. One goal would be to get rid of the $3.0 billion bridge loan. Another issue is that it is forecasting to generate enough pro-forma EBITDA to chop down the debt in a number of years.

As Western Digital is now offering more shares for SanDisk, the purchase price of SanDisk is now roughly $16.2 billion. This is after a recent failed investment took place.

What many investors remain concerned about is that Western Digital is planning to offer some $17 billion or so in debt to help pay for the SanDisk buyout. Of that large sum, $3.0 billion will be a bridge loan. The rest is a set of traunches that are secured and unsecured debt. The company also telegraphed that it should be able to tap $4 billion of SanDisk’s cash to repay the bridge.

Western Digital is looking for lower operating and general costs on the combined company, versus the two companies being independent. It has even forecast total post-merger synergies of about $500 million within 18 months after it fully integrates SanDisk. Longer term, by 2020, the company has suggested that its annual savings could be $1.1 billion per year. As for earnings, Western Digital said:

The transaction is expected to be EPS accretive on a non-GAAP basis in Calendar Year 2017. Pending the closing of the transaction, Western Digital expects to continue paying its quarterly dividend and has already suspended its share buyback program.

As far as whether the company can accomplish that, it is worth looking at raw expenses. SanDisk in the year 2015 had expenses of $883 million for research and development and $561 million for selling general and administrative. Western Digital’s expenses are over a year-end from July, but its annual expenses were $ 1.65 billion for R&D and $964 million for SG&A.

The bulk of synergies and savings are projected to be integrating NAND supplies to the legacy solid state drive operations rather than purchasing from Intel. This could save as much as $6750 million by 2020, but that was put at a $200 million rate 18 months or so. The HGST unit could drive another 650 million or so in savings.

It is too soon to expect many analyst reports to chime in here since the latest merger-savings projection.

Merrill Lynch has a Buy rating on Western Digital and the firm kept its price objective at $76.00. That compares to a more recent share price of $46.44. Its investment rationale said:

We believe negative impact to HDD TAM, from a PC down cycle, is already incorporated in investor estimates for Western Digital and that fundamentals have bottomed. Additionally, we still view Western Digital as a net beneficiary of the data storage growth, with demand for capacity enterprise drives, as well as solid-state-drives. Western Digital is also taking share from Seagate in the capacity enterprise market. This should result in expanding margins and EPS, combined with strong FCF generation, making it an attractive story.

If Investor’s Business Daily is correct, then Western Digital shareholders are expected to approve the deal for SanDisk.

Shares of Western Digital were last seen up 2.3% at $47.55. Its consensus analyst price target is $73.00 and its 52-week trading range is $38.64 to $102.07. Western Digital’s market cap is $11.1 billion.

SanDisk’s stock price was up only 0.5% at $76.35. The consensus price target is $76.12. SanDisk’s 52-week range is $44.28 to $87.43, and its market cap is $15.3 billion.

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