3 Reasons You Should Love This Deal

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Western Digital (NASDAQ: WDC) announced a deal to acquire the solid-state drive (SSD) company STEC (NASDAQ: STEC) on Monday for slightly more than $310 million. While investors have pointed to both the good and bad of the deal, Western Digital is currently trading lower by 2%. With that said, I love the deal, and here are three reasons why!

The Best Of Both Worlds

All the data that flows through the cloud, on e-commerce, and on mobile must be stored, and it is stored on SSDs. Western Digital is one of the two largest hard-disk drive (HDD) companies in the market -- with the other being Seagate Technologies (NASDAQ: STX) which stores data for PCs, laptops, DVRs, game consoles, and more physical devices.

The HDD and SSD markets both have their positives and negatives. The HDD market produces exceptionally high operating margins but has seen top-line declines due to slumping PC sales. The SSD market is growing rapid, but is ever-evolving and produces very low operating margins.

Western Digital now has the best of both worlds. STEC produced revenue of just $140 million over the last 12 months; less than 1% of Western Digital’s business. However, with this acquisition, Western Digital is obtaining their patents, technology, and can incorporate STEC’s products into its supply chain; allowing for faster growth and higher margins.

Furthermore, STEC’s products are known for endurance, which Lazard Capital’s Edward Parker believes will bode well for Western Digital’s OEM and enterprise clients. With this purchase, Western Digital now has an edge in these segments, and can further expand across the cloud.

It’s All About The Price

It seems as though any cloud play in the market comes with insane metrics and high valuations relative to fundamentals. STEC is a company that has seen drastic revenue losses over the last year, as management mishaps and poor execution has plagued its progress. However, this is still a high-growth industry, as other cloud plays trade at 10-15 times sales.

With Western Digital’s acquisition, it was able to purchase the company at just 1.5 times 2013 expected sales. Analysts have already spoken, and have said that Western Digital will have the capabilities to grow STEC’s primary business significantly faster than what STEC could achieve alone.

Thus, this is an acquisition that could return gains for Western Digital in a timely fashion. Most likely, this won’t be a lingering acquisition, one that sits on the company’s balance sheet as an overhang. Instead, it will be beneficial, and as an investor, I am highly encouraged by the purchase price in which Western Digital paid to acquire the company.

Final Thoughts

This acquisition does not make Western Digital a leader in the SSD industry, but it gives the company a presence. It gets their foot in the door, and because of the company’s size, all they need is a foot, and then they have the resources available to explode with growth. It gives the company a dual-threat, and an edge over Seagate Technologies.

This is my third takeaway, because neither Western Digital nor Seagate have been active in expanding their SSD lineups. In fact, Seagate might have been more active, expanding both its consumer and enterprise businesses with SSD integration. But like I said, STEC’s “endurance” and the longevity of its services will benefit those enterprise clients who seek consistency and fewer mishaps of their data; more-so than high-performance.

Over the last six months, Western Digital has been gaining market share while Seagate loses its share. It appears as though this acquisition may be a direct attempt for Western Digital to further steal the enterprise business from Seagate, with a much more effective SSD lineup for enterprise clients with the acquisition of STEC.

With that said, the deal itself is expected to close in Q4, and I would watch for its effect on Seagate in the enterprise business. Also, I’d watch for Seagate to make a big acquisition of its own, possibly OCZ Technology? Overall, I think Western Digital just forced the combination of two storage industries, which should bode well for both them and SSD companies that are waiting to be acquired. 

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Brian Nichols is long WDC. The Motley Fool owns shares of Western Digital.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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