Toshiba: a Tale of NAND and PE

Up until the day I came back from Korea, and a for a few days since then, I followed a very interesting story concerning the Japanese company Toshiba (TYO:6502), specifically the story surrounding the sale of its NAND flash division following the bankruptcy of its US nuclear operations in Westinghouse. It was an interesting race, filled with big names from across the world. But then, I soon lost interest in the story. Until recently.

I recently came across an article on Engadget concerning Toshiba’s sale of its TV unit to Chinese appliance manufacturer Hisense (SHA:600060). In the introduction to the article, they mention briefly 2 previous sales of other Toshiba businesses, one of them being Bain Capital’s recent takeover of Toshiba’s NAND flash business for $18 billion dollars.

Obviously, in the typical private equity (aka PE) fashion, the capital wasn’t just from Bain itself, but from a consortium of interests ranging from competitor SK Hynix (KRX:000660), to customer Apple (NASDAQ:AAPL). You can check out the full list of the consortium here. In the link, you will see the structure of the deal as well, which, in and of itself, is very interesting (especially concerning a sticking point of the sale was SK Hynix’s involvement in the consortium). Even without this detail, however, it’s a very interesting story, with so many questions left unanswered at the time of writing (at least for me).

First, let’s take a look at the NAND flash market at large. In 2016, the NAND flash market saw, what I categorize, as an uncharacteristic shortage in the market. This was fueled by a strong growth in demand for SSDs, RAM, and other NAND chips in both consumer, and enterprise applications (Source). This uptick in demand was well within expectations, however. What wasn’t were the manufacturing constraints companies faces, across the board.

The simple answer is that manufacturers are currently shifting away from 2D NAND chips to 3D NAND, in an effort to further reduce the cost per GB, and stay competitive. Simply put, the current technological trajectory has hit a proverbial wall, and manufacturers are working to jump to a new technology (Source). There have been talks of ReRAM and PCM, but the big players in the market (namely Samsung and Intel) seem to have made their choice in 3D NAND.

NOTE: It seems the term 3D RAM might be a marketing term gone generic, first coined by the folks at Intel. Just a hunch, because Samsung’s branding goes by V-NAND for Vertical NAND (an allusion to the vertical stacking of NAND gates in 3D NAND).

So manufacturers are moving away from investing in traditional, 2D NAND manufacturing facilities, to investing in new manufacturing processes for 3D NAND. In short, they’re in a transition phase. As a result, they’ve unwittingly, artificially constrained the supply of NAND chips, and have thus increased the market price. This has led to forecasts of the NAND market growing 17% in market value year over year (Source).

Judging by all this, it’d be simple to assume that Bain made a bid for Toshiba’s NAND flash business (the 2nd largest in the world behind rival Samsung), because it sees an opportunity to make optimizations in Toshiba’s business and manufacturing processes to increase margins, profitability, and competitiveness. In fact, the PE firm has said it’s looking to list the company within 3 years. But that’s the simple explanation. And it leaves a lot of questions.

For example, it’s pretty difficult to understand, personally, why Toshiba would be selling its NAND division, when it has a good market standing, even in the status quo. Even on their financial reports, it’s quickly apparent that what they call “storage & electronic devices solutions” is the largest, and the best performing business they have. Obviously the NAND business is only a portion of this category, but that ignores the fact that the company has other divisions to sell to help cover the accounting hole on its balance sheet. The only reasoning I could muster up is that the company is genuinely concerned with becoming delisted.

The second looming question has to be concerning the NAND chips themselves. the industry standard lifespan for a given NAND scale generation is 2 years. Given that most people familiar with the industry see 3D NAND going into 3 generations of scale, this gives 3D NAND 6 years of market lifespan. Maybe 8 if things work out well. The source article is from 2014, and at the time, it claimed 3D NAND will be mass market ready in 2017, well in line with reality (as most manufacturers today are transitioning in preparation for next year). This means that by the time 2020 rolls around, the main headline might not be 3D NAND anymore, but an entirely different tech altogether. This might drain the future value of Bain’s investment in Toshiba’s NAND business.

The third question I have is more about the Japanese PE market at large. This is, by far, the biggest PE deal in the country’s history, which pales in comparison to the deals made in the US over its history. Even China’s PE market was, and still is, more active and vibrant than Japan’s.

In fact, in the past, Western Digital’s bid to buy out Toshiba’s NAND operations would have been a shoo-in bid. Bain’s bid might not even have been considered. But the recent increase in PE spending in Japan, and the increase in the number of deals awarded to PE firms marks a shift in the market. What’s the underlying reason behind this stagnation, and why has the market opened up recently to PE funding? Perhaps it’s shifts in demographics, changes in rules on corporate governance, and an increase in IPO activity that made the market more ready for PE funding.

Or perhaps there’s a genuine opportunity to take global brands with outdated practices out of the dark ages. Sony is a great example of this. The company, specifically in the late 90’s up until the early 2010’s, was struggling financially, with increased competition from South Korean and Chinese competitors in the consumer electronics space. Moreover, its acquisition of Columbia Pictures and CBS Records proved financially imprudent, further cash strapping the struggling company. This was worsened by Howard Stringer’s focus on the media businesses of Sony, taking resources away from more competitive divisions within the company.

It was in 2014 that Sony began its fervent search of profitability with the sale of its VAIO PC unit to Japanese PE firm Japan Industrial Partners (which happens to be backed by a certain Bain Capital). If you ask me, this marked the first sign of a changing Japanese market. Panasonic, Sharp, they too were downsizing, but their businesses ended up in the hands of Chinese competitors (Sharp’s sale of its US TV business to Hisense, for example). Private equity was rarely, if ever, considered during the bidding process. But once Sony, once equivalent to brand Japan itself, offered itself up for PE funding, the floodgates swung opened.

Whether this change is permanent, or a one time fad, remains to be seen. It all depends on the returns PE firms can garner from these big profile deals. All I know is that, right now, PE firms have it better than ever in Japan. And with global brands that are looking to streamline their businesses in response to global competition (e.g. Sony’s TV/display business), I foresee more and more business divisions from these brands being put up for sale in the near future. Whether they make sound investments is a whole other story.


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