Some thoughts on the Kioxia/WDC NAND integration

Recently there have been rumors in the press about a possible merger of Kyoxia and Western Digital’s NAND flash and SSD divisions. Western Digital may have sought to buy what had been Toshiba Memory when Toshiba Memory (since renamed Kyoxia) exited Toshiba in 2018 to raise funds to support operations for its troubled parent company. Working together with Toshiba to get the best terms for its next NAND flash and SSD business.

The latest speculation is that WDC is considering separating its hard disk drive and flash memory businesses in a June 2022 deal with activist investor Elliott Management. Since then, the company has considered creating separate businesses, selling flash businesses or other options. Recent rumors suggest that a decision on the future of WDC’s storage businesses will be made in the near future.

Let’s take a look at what the benefits and costs might be for WDC to sell its flash memory business to Kioxia. First, let’s look at the market share of the major NAND vendors. According to Trendforce Q3 2022, Samsung has 31.4% of the market followed by Kioxia at 20.6%, SK hynix and Soldigm (Intel’s former NAND business) at 18.5%, WDC at 12.6%, Micron at 12.3% and other companies ahead at 4.6%. Combining Kioxia and WDC’s NAND business would lead to the largest NAND manufacturer at 39.1%, but things never work that way.

If Kioxia and WDC combine, some customers may move some of their business from the new joint venture to other suppliers in order to reduce their reliance on that company and support its competitors. That was the case in the 2010s when there was a major consolidation of HDD companies. Therefore, a combined Kioxia and WDC may not be the market leader, at least not for long.

Also, let’s look at WDC’s Flash and HDD revenues and profits from their quarterly reports to see how the two WDC businesses compare. The table below shows the company’s NAND Flash and HDD quarterly revenues from CQ1 2020 to CQ3 2022. From a revenue perspective, the two businesses track each other, with the HDD business usually generating higher revenue each quarter.

In the following chart we show the gross margin of WDC NAND flash and HDD business. WDC NAND gross margins are generally higher than the HDD business. Gross margins should generally be related to the profitability of businesses. Note that the slight decline in HDD business margins in CQ2 2022 is due to a large correction in the company’s HDD business, a continued decline in the company’s legacy business, and post-pandemic overstocking in the HDD business. After talking about Kyoxia’s financials over the last few years, we’ll talk about WDC NAND’s profitability again.

The following chart shows Kyoxia’s yen sales and profits from their quarterly report. Sales have generally increased from CQ1 2020 to CQ3 2022, but the company’s profits are more volatile. Kioxia and WDC get NAND flash from the same fabs in Japan, why is there such a difference in the profitability of the two businesses?

Objective Analysis analyst Jim Handy has written an article analyzing the profitability of WDCs NAND business and Kioxia business in 2019. Jim pointed out that the business arrangement between WDC and Kioxia (then Toshiba Memory) allowed WDC to take up to 50% of the output. Joint Venture Fab. But they don’t have to take their full 50% share and only have to pay Kioxia for the output 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 as the factory can recover the capital cost of the factory.

This gives WDC an advantage as the demand for flash memory decreases and the cost decreases. The company can control its losses by only taking as much production from the joint venture as it can sell, while Kioxia will not take what WDC can and should try to sell their shares. This will result in additional cost pressure for Kyoxia. As a result of this agreement, WDC NAND’s business profitability will 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 certainly gain, but WDC will lose a good source of revenue and profit. So, it would be amazing if WDC did that. They could separate the two businesses as separate companies, as long as the new NAND business retains its brand agreement with Qiaoxia, but it doesn’t seem to make sense for WDC to sell its NAND business to Qiaoxia.

Looking at the fab arrangement between Kioxia and WDC and the track record of NAND commercial profitability, a merger of the two companies would be more beneficial to Kioxia than WDC. This makes it hard to believe that WDC will drive this trade to Kioxia, but only time will tell.