Some Thoughts on a Potential Kioxia/WDC NAND Merger

Recently there have been rumors in the media that Kioxia and Western Digital’s NAND Flash and SSD divisions may merge. Western Digital may have pursued a potential acquisition of Toshiba Memory (later renamed Kioxia) when it was spun off from Toshiba in 2018 to raise funds to fund operations of its troubled parent company. Western Digital is likely to use its flash memory joint venture with Toshiba to secure the best terms for its continued NAND flash and SSD business.

The latest speculation has been fueled by a June 2022 settlement from activist investor Elliot Management that says WDC will consider spinning off its hard drive and flash memory businesses. Since then, the company has considered whether creating a separate business, selling the flash business, or other options made sense. Recent rumors suggest that the future of Western Digital’s storage business will be decided in the near future.

Let’s look at the possible benefits and costs of WDC selling its flash memory business to Kioxia. First let’s look at the market share of the major NAND suppliers. According to Trendforce data in the third quarter of 2022, Samsung has a 31.4% market share, followed by Kioxia with 20.6%, SK Hynix and Solidigm (Intel’s former NAND business) with 18.5%, WDC with 12.6%, and Micron with 12.6%. 12.3%, and other companies accounted for 4.6%. On the face of it, combining Kioxia’s and WDC’s NAND businesses would make it the largest NAND manufacturer with 39.1%, but things will never play out that way.

If Kioxia and WDC merge, some customers will likely shift some of their business from the new joint venture to other suppliers in order to reduce their reliance on the company and support its competitors. This was certainly the case when there was a major consolidation of hard drive companies in the 2010s. As such, a combination of Kioxia and WDC probably won’t be the market leader, at least not in the long run.

Also, let’s look at WDC’s Flash and HDD revenue and profit from quarterly reports to see how the two WDC businesses compare. The chart below shows the company’s quarterly NAND flash and HDD revenue from the first quarter of 2020 to the third quarter of 2022. From a revenue standpoint, the two businesses somewhat track each other, with the HDD business typically generating the most revenue each quarter.

In the chart below, we show gross margins for WDC’s NAND Flash and HDD businesses. WDC’s NAND gross margin generally exceeds its HDD business. Gross margin should generally correlate to the profitability of a business. Note that the slight decline in HDD margins in 2Q22 is due to a major realignment in the company’s HDD business, which continues to decline during the pandemic and following excess inventory in the nearline HDD business. After talking about Kioxia’s financial situation in recent years, let’s talk about WDC’s NAND profitability.

The chart below shows Kioxia’s sales and profits in Japanese Yen in its quarterly report. Sales have generally been growing from the first quarter of 2020 to the third quarter of 2022, but the company’s profit dynamics are much larger. Kioxia and WDC’s NAND flash come from the same Japanese fab. Why is there such a big difference in the profitability of the two companies?

Objective Analysis analyst Jim Handy wrote an article as early as 2019 analyzing the profitability of WDC’s NAND business and Kioxia’s business. Jim pointed out that the business arrangement between WDC and Kioxia (then Toshiba Memory) allowed WDC to take up to 50% of the output of the joint venture factory. However, they don’t have to take the entire 50% stake, they just pay Kioxia for the products they get from the joint venture factory. NAND flash fabs are very expensive to build, and once built, it makes sense to manufacture as many products as possible, since the fab is able to generate a return on the capital cost of the fab.

This gives WDC an advantage when demand for flash memory falls and prices fall. The company can limit potential losses by only getting as much product as possible from the joint fab, while Kioxia needs to try and sell their stake plus what WDC didn’t take. This puts additional price pressure on Kioxia. Because of the agreement, the profitability of WDC’s NAND business tends to be more stable than that of Kioxia.

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

Judging from the fab arrangement between Kioxia and WDC and the profitability history of both companies’ NAND businesses, the merger has an advantage for Kioxia over WDC. This makes it hard to believe that WDC will spin off this business to Kioxia, but time will tell.