Western Digital's $4.3 billion Hitachi deal creates giant

BANGALORE/TOKYO Mon Mar 7, 2011 7:28pm EST

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BANGALORE/TOKYO (Reuters) - Western Digital Corp's WDC.N deal to pay $4.3 billion for Hitachi Ltd's (6501.T) hard disk drive business will arrest a margin-slicing price war and create a global leader with the resources to develop costly next-generation storage technology.

The largest tech deal to be struck this year caps years of consolidation for a beleaguered industry that has battled persistent sales growth declines, and now faces a longer-term threat from wireless devices like Apple's (AAPL.O) iPad.

Investors pushed Western Digital's stock 16 percent higher and Hitachi's U.S.-listed stock HIT.N up 5 percent.

The marriage of the sector's No. 2 and No. 3 players removes excess capacity and should stem a price war. Shares in rival Seagate Technology (STX.O) -- which dived 18 percent in 2010 -- leapt 12 percent.

"Hitachi to a large extent was considered a price breaker and due to a lack of pricing discipline they had created a very negative profitability environment for the industry," said Rodman and Renshaw analyst Ashok Kumar.

Executives said the acquisition should now lift Western Digital's long-term margin targets by about 1 percentage point annually to 19 to 24 percent through a combination of cost savings and expansion into higher-margin corporate businesses.

Western Digital and Seagate have been struggling to adapt to a future where fewer consumers tote laptops. Flash drives, or solid-state drives, consume less power and are faster and are viewed by many as the future of the disk drive industry.

They are increasingly being built into laptop PCs and tablet computers like Apple's iPad. In March, Gartner slashed its 2011 PC growth forecast by more than 5 percentage points to 10.5 percent. iSuppli estimates hard drive shipments worldwide will decline more than 4 percent in the current quarter.

The deal grants Western Digital access to the higher-margin corporate segment of the hard drive market and also to Hitachi Global Storage Technologies' (HGST's) solid-state drive offerings, Wedbush analyst Kaushik Roy said.

"Clearly every drive vendor is required to have a story for solid state drives," said Carl Amdahl, a venture capitalist with a focus on semiconductor investments at DCM in Menlo Park, Calif. "Because SSDs are taking more high-end business it seems that Western Digital is nicely positioned now, whereas Seagate has to evolve its position a bit more."

Hitachi had forged a partnership with Intel Corp (INTC.O) that allows it access to the chipmaker's NAND flash technology -- an edge for Western Digital in a capital-intensive business. Executives said on a conference call they were committed to maintaining that relationship with the world's top chipmaker.

"SSD will be a key part of the combined entity strategy," said Hitachi GST CEO Steve Milligan, the former Western Digital CFO credited with turning around the Hitachi unit.

He will return as Western Digital's President.

LOOKING TO THE FUTURE

Increasingly used in smartphones, flash storage is deemed 5 to 10 times more expensive than traditional drives but market leaders Samsung Electronics (005930.KS), Toshiba Corp (6502.T), SanDisk (SNDK.O) and Intel are investing billions of dollars to boost production.

STEC Inc STEC.O is now the biggest player in flash storage for businesses, but its executives have long warned that other players, including Hitachi, will increasingly eat into its 80-percent market share.

Toshiba, Samsung and Fujitsu (6702.T) are other players in the hard-drive space, while the solid-state or flash market is now dominated by Intel, Micron (MU.O) and Samsung.

Shares in flash memory supplier Micron Technology (MU.O) slid 7 percent as investors pondered a new, and much larger, rival in the U.S. market.

The creation of such a dominant industry force - controlling about 50 percent of the market -- is sure to invite antitrust scrutiny. But Western Digital executives said the company is hopeful customers will like the deal because it gives them access to a broader product range.

For its part, Hitachi had been looking to list its unit to tone down its involvement in volatile businesses. Led by President Hiroaki Nakanishi, it has overhauled its sprawling empire of some 900 firms to focus more on stable and growing infrastructure-related businesses.

"The initial public offering was highly unlikely given the industry outlook," Kumar said. "The writing was on the wall."

Nakanishi told a briefing in Tokyo that he planned to use the funds raised in the sale for investments to bolster its "social innovation" segment, which includes power plants, smart grids, batteries and railway systems.

Post-deal, Hitachi will own 10 percent of Western Digital.

"The target company was heads down full speed ahead on the IPO," a source close to the situation said. "Western Digital thought it would make sense to reach out and see if there is any interest in pursuing an M&A transaction and so WD tapped them on the shoulder and they said we are all ears."

Executives said Western Digital used mostly offshore cash to bankroll the deal, avoiding taxes on repatriation. It will pay $3.5 billion in cash and $750 million in stock for HGST.

Bank of America-Merrill Lynch advised Western Digital. Goldman Sachs was exclusive adviser to Hitachi.

Western Digital shares closed at $34.68. Seagate stock finished up 9 percent at $13.56 on Nasdaq. Shares of SSD maker Micron Technology were down 5.2 percent at $11.03 on Nasdaq.

(Additional reporting by Nathan Layne in Tokyo, Noel Randewich in San Francisco, Himank Sharma in Bangalore and Nadia Damouni in New York; Editing by Saumyadeb Chakrabarty, Edwin Chan and Bernard Orr)

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