Some perspectives on a potential Kioxia/WDC NAND merger

Rumors recently appeared in the press about a possible merger between Kioxia and Western Digital’s NAND flash and SSD division. Western Digital may have been looking at a potential buyout of what was Toshiba Memory (since renamed Kioxia) when it was spun off from Toshiba to raise money to fund the troubled parent company’s operations in 2018. More than likely, Western Digital is used its flash memory joint venture with Toshiba to get the best terms for its ongoing NAND flash and SSD business.

Recent speculation stems from a June 2022 deal with activist investor Elliot Management, which says WDC will consider spinning off its hard drive and flash memory businesses. Since then, the company has been considering whether creating separate businesses, selling the flash business or other options made sense. Recent rumors indicate that a decision on the future of WDC’s storage business will be made in the near future.

Let’s take a look at what the benefits and costs could be for WDC from selling its flash memory business to Kioxia. First let’s look at the market share of the major NAND vendors. According to Trendforce, in Q3 2022, Samsung had 31.4% of the market, followed by Kioxia with 20.6%, SK hynix and Solidigm (formerly Intel’s NAND business) with 18.5%, WDC with 12.6% , Micron at 12.3% and other companies at 4.6%. On the face of it, combining Kioxia and WDC’s NAND business would make it the largest NAND producer with 39.1%, but things never quite pan out that way.

If Kioxia and WDC merge, it is likely that some customers will shift some of their business from the new joint venture to other suppliers in order to reduce their dependence on that company and support its competitors. This was certainly the case when there were major HDD company mergers in 2010. So the combination of Kioxia and WDC may not be the market leader, at least not for long.

Also, let’s take a look at WDC’s flash and HDD revenues and profits from their quarterly reports to see how WDC’s two businesses compare to each other. The chart below shows the company’s quarterly NAND flash and HDD revenue from CQ1 2020 to CQ3 2022. From a revenue perspective, the two businesses are somewhat in step with each other, with the HDD business typically generating the most revenue each quarter.

In the following chart, we show the gross margin of WDC’s NAND flash and HDD businesses. WDC’s NAND gross margins generally exceeded those of the HDD business. Gross margins should generally correlate with the profitability of the business. Note that the small decline in HDD business margins in CQ2 2022 was due to a large correction in the company’s HDD business with continued declines in the company’s legacy business following a push during the pandemic and excess inventory in the HDD business in closeness. We’ll talk about WDC’s NAND profitability again after talking about Kioxia’s financials over the past few years.

The following chart shows Kioxia’s sales and profit in yen from their quarterly reports. Sales generally increased from CQ1 2020 to CQ3 2022, but the company’s profit was much more dynamic. Kioxia and WDC get their NAND flash memory from the same factories in Japan, why is there such a difference if the profitability of the two businesses?

Analyst Jim Handy of Objective Analysis wrote an article analyzing the profitability of WDC’s NAND business and Kioxia’s business in 2019. Jim points out that the business agreement between WDC and Kioxia (then Toshiba Memory) allows WDC to take up to 50% of the output of the joint venture fab. However, they do not have to take the full 50% of their share and only have to pay Kioxia for the product they take from the joint venture factory. NAND flash factories are very expensive to build, and once built, it makes sense to produce as much product as the factory is able to get a return on the factory’s capital expenditure.

When demand for flash memory drops and prices fall, this provides an advantage for WDC. The company can control potential losses by taking only as much output from the joint factory as it can sell, while Kioxia must try to sell its share plus what WDC does not take. This causes additional price pressure for Kioxia. As a result of this arrangement, WDC NAND’s business profitability tends to be more stable than Kioxia’s.

With this information, would it make sense for WDC to sell its NAND flash business to Kioxia? Kioxia will definitely win, but WDC will lose a good source of revenue and profit. So it would be surprising for WDC to do this. They could separate the two businesses as separate companies as long as the new NAND business keeps the product deal with Kioxia, but it doesn’t seem to make sense for WDC to sell its NAND business to Kioxia.

Looking at the great agreement between Kioxia and WDC and the history of NAND business profitability for both companies, a merger would be much more beneficial for Kioxia than for WDC. This makes it hard to believe that WDC will hand over this business to Kioxia, but only time will tell.