When Toshiba put its chip unit on the auction block eight months ago, Western Digital CEO Steve Milligan's team seemed to have some advantages over deeper-pocketed rivals, but Bain Capital won the prize finally
Steve Milligan was ready to declare victory. A statement was drafted and a photographer was getting lined up for a hand-shake ceremony planned in Tokyo. As the brash Silicon Valley executive prepared to announce the biggest deal of his career, a prominent Japanese newspaper was reporting his consortium had clinched an agreement to buy Toshiba Corp.’s semiconductor unit, the country’s last big chip business.
Except that they hadn’t. Before Milligan could strike a pose for the cameras, the deal was off. For the chief executive officer of Western Digital Corp., it was the latest misread in a string of them.
When Toshiba put its chip unit on the auction block eight months ago, Milligan’s team seemed to have some advantages over deeper-pocketed rivals. As Toshiba’s partner in the memory business, it had legal leverage that could be used to scare other bidders away. The Japanese conglomerate faced staggering losses from its bankrupt nuclear reactor business and was being pressured by lenders to close a deal quickly.
It would require more than a little diplomacy to win over Toshiba, the banks and Japan’s bureaucrats. Yet the 53-year-old deal maker soon alienated Toshiba executives central to the business.
In the end, private equity firm Bain Capital won the prize, thanks in part to the last-minute intervention of Apple Inc., one of Toshiba’s biggest customers, which helped Bain put together an $18 billion offer. In Japan, money talks just like anywhere else. But there were other considerations.
“With so many stakeholders to please, the deal was always going to be tough and it required more finesse than Western Digital had," said Damian Thong, a Tokyo-based technology analyst at Macquarie Group Ltd. “This was essentially a high stakes game of poker and Western Digital overplayed its hand."
The company declined to comment for this story and declined to make Milligan available. Toshiba also declined to comment. This account is based on interviews with more than a dozen people closely involved in the negotiations, who asked not to be identified because the details are private.
An accountant by trade, Milligan built his career as a deal maker in the hard disk drive industry, a notoriously cut-throat business that author Clayton Christensen used as the template for his 1997 bestseller, “The Innovator’s Dilemma," a book about how tech companies go bust when they can’t adapt fast enough.
Milligan navigated a difficult route to the top of Western Digital. At one point he left the company, where he was chief financial officer, to take the helm at a troubled rival owned by Japan’s Hitachi Ltd. Then in 2011, he turned around and sold the business to his former employer for almost $5 billion. The deal made Western Digital the industry’s biggest player and Milligan its CEO.
Still, the manoeuvring came amid bigger changes that meant hard disk drives would eventually be replaced by semiconductors. Chips were increasingly catching up to the older technology in terms of price and capacity without the downside of having spinning magnetic disks.
Under that pressure, Milligan last year made an even more ambitious move. He spent $16 billion, an amount about equal to Western Digital’s market value then, to buy SanDisk Corp., a semiconductor maker that depended on a longstanding joint venture with Toshiba for its chips. In a sign of how important the deal was to Western Digital’s future, Milligan moved his office to SanDisk’s old headquarters in Milpitas, California.
The buyout gave Western Digital the right to chips manufactured at Toshiba’s plant in Yokkaichi, a massive complex of factories where SanDisk had split some of the cost of machinery over the years. But it wasn’t a marriage of equals. Toshiba had invented the technology, and the Japanese conglomerate owned the land under the Yokkaichi factory, its buildings and almost all of the intellectual property its employees used to make the chips.
“From Toshiba’s point of view, Western Digital was like their younger brother," said Yukio Sakamoto, a veteran of Japan’s chip industry and former CEO at Elpida Memory Inc., the Tokyo-based semiconductor maker that went bankrupt in 2012. “Imagine your kid brother trying to boss you around. You can see why things got emotional."
The balance of power shifted last December, though, when Toshiba hit a crisis. Top executives at the parent company announced they’d discovered construction delays and cost overruns at four atomic reactors in the US had led to billions of dollars in losses. To pay its debt, Toshiba had to put its most profitable business, the chip unit, on the auction block.
With the SanDisk acquisition just completed, Milligan didn’t have the money to do another massive deal, but the prospect of owning Toshiba’s crown jewel was tantalizing.
“It was a once in a lifetime chance to vault into the top ranks of chip players," said Thong, the Macquarie analyst.
Behind Samsung Electronics Co., Toshiba is the biggest producer of an increasingly essential piece of hardware: flash memory, the chips that replaced film inside cameras and are now key to just about every portable electronic device, including the iPhone. The latest generation of these chips, which can squeeze even more data into a smaller space, will likely help Toshiba and Samsung widen their lead over everyone else—and eat further into the hard disk drive market.
Tempers first flared at an April meeting at Western Digital’s headquarters, where Milligan sat across from Toshiba’s head of the chip unit, Yasuo Naruke. The American CEO made a low-ball offer of $13 billion for the business and said he’d use his rights as Toshiba’s partner to block a sale to anyone else, according to people who attended the meeting.
With a helmet of dark hair parted neatly on the side, Naruke projects an image of calm restraint, but the 62-year-old engineer fumed the whole way home to Tokyo on the airplane, according to the people. He believed Milligan was trying to take advantage of Toshiba’s problems to buy the chip business on the cheap, they said.
People familiar with the thinking of Western Digital executives say Toshiba was given no ultimatum at the meeting and the $13 billion figure was only a preliminary test of pricing. Milligan only expressed concern the business might be sold to investor groups that included Western Digital’s competitors, his fiduciary responsibility, they said.
“The impression at Toshiba is that they waited until they had the most leverage to make their move," said Jason McBride, a former Western Digital employee who left before the SanDisk acquisition and now works at Toshiba as senior marketing manager in San Francisco. “It went from ‘it’s all about trust’ to ‘let’s get down in the mud."’
Over the next months, Milligan escalated his efforts. In May, Western Digital’s lawyers challenged Toshiba in arbitration over its right to sell the business unilaterally and in June they asked a California court for an injunction to block any deal.
Rival bidders received letters threatening lawsuits, according to at least two people who got the missives. A letter from Western Digital to Foxconn Technology Group, an early bidder, said merely reviewing due diligence documents from the chip business might violate Western Digital’s confidentiality agreements with Toshiba, according to a copy obtained by Bloomberg.
By early September, the threats appeared to be paying off. Key investors in a rival consortium led by Bain were scared away. State-backed Innovation Network Corp. of Japan and Development Bank of Japan Corp. wouldn’t sign checks until the lawsuits were resolved, so Japan’s trade ministry shifted its support to Western Digital.
The banks, desperate to get a deal done, also reasoned the quickest way to end the litigation was to let Milligan win, according to several people familiar with the events. Stock exchange rules gave Toshiba until March 2018 to close a sale or risk being delisted.
But as Milligan and his team prepared for victory, Bain wasn’t conceding. The Boston-based private equity firm had competed in dozens of contentious buyout battles over the years, and the presumptive favourite in the Toshiba deal had changed more than once.
In March, Taiwanese electronics maker Foxconn indicated willingness to pay as much as $27 billion, but was ruled out because of its ties to China. In April, chipmaker Broadcom Ltd had a brief moment in the lead. Then, in June, Bain’s group was named the preferred bidder, with a $19 billion offer that was supposed to include financing from government-backed lenders, who balked.
To fill the void, Bain needed new investors. Early last month, Bain executives led by David Gross-Loh, co-head of the firm’s Asia business, made a trip to Cupertino to lay out a case for Apple CEO Tim Cook. Apple had reason to want someone other than Milligan to succeed: a Samsung-Western Digital duopoly in the flash memory market could raise prices. Apple gave Bain the swing vote it needed.
Eight months of wild negotiations ended last week, when Toshiba finally agreed to sell to a group of investors including Bain, Apple and Dell Inc. The deal was engineered so that Toshiba and Hoya Corp. will hold a majority of the voting stock, a solution that keeps control of sensitive technology in Japanese hands. The transaction is still subject to regulatory approvals.
Meanwhile Milligan, who just weeks ago seemed poised to win it all, may be left in a worse position than when the jockeying for advantage started late. Not only does the winning investor group include competitors Seagate Technology Plc. and SK Hynix Inc., but the relationship with Toshiba is badly damaged. The Japanese company is building factories that will make the next generation of flash memory and says it may leave Western Digital out. That would leave the company unable to supply customers with the latest technology.
Western Digital is still threatening to use arbitration to try to stop the deal from closing, and the company’s lawyers say litigation could drag on until 2019.
“We intend to continue our successful legal efforts into the binding arbitration process," John Hueston, counsel for Western Digital and partner at Hueston Hennigan, said in a statement last week.
Toshiba and Bain are confident they will prevail in arbitration, people familiar with the matter said. The agreement calls for the sale to be consummated even if the litigation is unresolved.
So far, Western Digital’s shareholders don’t appear to be terribly concerned. The stock price has changed little since the deal was announced last Thursday, after climbing 27% this year. Among the 29 Wall Street analysts who cover the company, 25 still recommend investors buy its stock.
Shareholder Charlie Smith, chief investment officer at Fort Pitt Capital Group in Pittsburgh, says he’s confident Western Digital will eventually win in court, but concedes it can’t afford to get locked out of the chip business by an angry partner.
“The disk drive business is a cash generator, but it’s going to be dead in five, six, eight years," he said. “They would be in a serious bind at that point." Bloomberg
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