Why Key Analyst Sees 30% Upside in Western Digital

Argus raised its rating on Western Digital to Buy from Hold and set a target price of $90, implying upside of nearly 29% from current prices.

This came on news that Unisplendour will acquire roughly 15% of the company for 3.775 billion or 92.50 per share. Western Digital will use the $3.8 billion cash infusion to strengthen its balance sheet. The number-one hard disk drive (HDD) manufacturer has been hurt by weak demand in the PC space, driven by secular disruption and cyclical weakness in emerging economies.

While the Unis bid is positive for the memory space overall, it does not solve Western Digital problems, which in the medium term are primarily related to weak HDD demand in the client (PC) space. In a slow-growth environment for HDDs, and given average selling price pressures, Argus expects constrained growth in total company revenue and earnings at Western Digital. At the same time, the company is showing promising momentum in non-client markets, and most notably enterprise HDDs and SSDs.

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Argus feels the significant decline in Western Digital from peak prices overstates the challenges facing Western Digital. The company derives about 10% of revenue from outside the HDD market, and this business is growing rapidly. In addition, in the HDD space, enterprise demand continues to grow. Over time, the firm looks for stabilization in the client business, as well as continued strength in the consumer and branded portions of the HDD market. Western Digital also will have a net cash position of about $6 billion, all else being equal, following the deal close.

In the report Argus said:

In our view, stock price declines in the data storage space overstate the risks to the industry. While pricing has weakened, demand growth has remained constant for the sector overall, even as PCs weaken. Semiconductor equipment companies such as Applied Materials and primary memory companies such as Micron are modeling average bit growth of 25% for DRAM and 35% for NAND in 2015. Over time, the contribution to DRAM demand from client (PC) will weaken. By 2019, the consumption of DRAM by server & data center will be two-times the consumption by client, and mobile DRAM demand will run at 1.5-times client consumption.

In terms of a broader perspective, the firm added:

Technology investments between China and the U.S. have historically been a one-way street. In September 2014, Intel announced a $1.5 billion in investment in subsidiary Tsinghua Unigroup, which owns mobile chip maker Spreadtrum. After Qualcomm and MediaTek, Spreadtrum is regarded as the number-three player in mobile chips. Marvell is the latest company to announce that it is exiting the mobile baseband and apps processor business, and Intel would like to move into a top-3 or even top-2 position.

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Shares of Western Digital were down 1.8% at $78.00 late Thursday morning. The stock has a consensus analyst price target of $98.95 and a 52-week trading range of $67.87 to $114.69. Western Digital is down 28% year to date, lagging the 14% decline for its peer group of computing and information processing companies in Argus coverage, but ahead of the 31% decline for data storage companies.

Stock prices for all companies associated with memory and data storage have fallen in calendar 2015, reflecting a multitude of negatives. Pricing for memory and data storage has declined on weakening demand from China and emerging economies and on market share turmoil in the mobile device space. Investors also are concerned about the costs of technology transitions and disrupted end markets.