Wednesday, 9 March 2011

an awesome HIT..........$WDC reaction

Huge news monday morning, and would have had more to say here if there wasn't the need to trade it. WDC are buying Hitatchi's storage business, the ominous "third player". The stock moved from $30 on Friday to $36 a pretty huge move. Having been short the stock and spent the last two days first buying back the small short and putting on a proper sized long its fair to say this is a game changer.

Removing this pricing pressure from the market has an enormous impact on the multiple that one should value wdc and seagate on. Without the deal the pricing situation was bleak. A large number of units overhanging that didn't seem to get cleared a siutation getting worse because Hitatchi was looking for an exit, and in so doing was trying to push up sales at the expense of margin for a potential IPO.

It was quite plausible that the selling prices could have been knocked down a further 5%. Just using the trailing 12 months, that would have reduced sales from $9.9bn to $9.4bn, and net profit to $0.58bn from $1.09bn. Putting that on a conservative multiple of 8x (which is justified for such a cyclical business) and adding in the $2bn of cash and you were looking at a price of ~ $28, but obviously with a lot more downside if the economy got worse or Hitatchi really started to blow out stock.

Whereas if we put on our rose tinted spectacles and dream, then WDCHIT looks pretty sweet; the combined group would have about $19bn of sales, on an 21% operating margin and all the synergies, and then a move up to a better multiple of lets say 10x and we're looking at $2.6bn net profit a year and a stock price of $100. yes triple.

Being very conservative, lets say a 50% leak, half synergies, 18% margin and the same old multiple 8x and we're at $36. Mid case and we're talking $55.

Lets make it even more simple, there are essentially three cases;
1) deal gets kaboshed - stock drops, $27
2) deal goes through, no synergies, high leak, no multiple expansion $36
3) deal goes through, land of milk and honey, $55

You can play around with probabilities and try to be really smart and work out a finer detail on this, however in the short term one has to recognize that the future has radically changed, and that historically markets don't digest that information quickly.

The same human nature that allows momentum to be a profitable strategy is at work, its hard to buy a stock that has gone up a large amount in a short period of time. Here we see the reason why and that there is a lot more upside potential.

The Raven has bought his position already, but will continue to add if the price action confirms this view.

Tomorrow some more thoughts as to those relative probabilites and how we're going to risk manage our position.

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