Analysis Western Digital Corporation continues its strange make love and war approach to getting a slice of Toshiba's Memory Business action by opening a new legal attack on its joint venture partner.
WDC announced today several of its SanDisk subsidiaries had filed an injunctive relief motion in the Superior Court of California for the County of San Francisco to prevent the transfer of its flash foundry joint venture with Toshiba (actually three individual JVs) until its existing arbitration request is decided by a tribunal.
Fresh bids were due today, Thursday, and Toshiba had said it will then pick a preferred bidder. WDC’s latest move has inserted a spanner in the works with likely delay.
It’s worth noting that there have been so many twists and turns in this bizarre affair it's best to look at the saga afresh to get a better handle on it. Then we will look at WDC's latest injunctive relief legal filing.
The ongoing crisis started in 2015 and has three aspects to it;
- 2015 Accountancy scandal
- 2016 Westinghouse Electric fiasco
- 2017 Auction of its Memory Business
Fundamentally Toshiba has lurched from crisis to crisis since 2015 due to bookkeeping problems; it’s bean counters couldn’t - or wouldn’t - count.
The 140 year-old corporation is a a great, great company with enormously successful technologies and products. It is a terrific shame that it has fallen on such disastrously hard times.
2015 accounting crisis
In 2015, an international panel found Toshiba had been "systematically falsifying" its books since 2008, as managers tried to meet overly ambitious targets and prevent and/or delay cost recognition. The investigation by the panel found profits had been inflated by $1.2bn over the previous seven years, and massive expenses hidden across the company.
CEO Hisao Tanaka announced his resignation in July of 2015, describing the accounting scandal the worst brand-affecting event in Toshiba's 140-year history.
The scandal opened a Pandora’s box for Toshiba and, ultimately, eight senior officials, including the two previous CEOs, fell on their swords.
Chairman Masashi Muromachi was appointed acting CEO. Net losses for the quarterly period were 12.3bn yen ($102m; £66m) with poor results in the TV, home appliances and PC business units. That September, the company's shares fell to a two-and-a-half year low.
Muromachi said in December that the accounting faux pas had destroyed about $8bn of Toshiba's market value, and predicted an annual and record loss of ¥550bn (about $4.6bn) annual loss. Toshiba would have to restructure its TV and computer businesses, and would not be raising any additional funds until 2018.
He was wrong as, in the following week, Toshiba said it would look to raise ¥300bn ($2.5 billion), which would lift its total debt past ¥1tn (about $8.3 billion). Such senior exec flip-flopping became almost normal as execs reacted to the fast-developing situation with inadequate knowledge.
Satoshi Tsunakawa, the former head of Toshiba's medical equipment division, was named the new CEO in May 2016. He set about cleaning the Augean accounting stables and refinancing Toshiba, hoping that Pandora's box had been emptied and all the skeletons were out in the open.
The company is suing Atsutoshi Nishida and four other former execs for ¥300m in damages for losses resulting from the bookkeeping. Nishida and the others deny any wrongdoing.
Toshiba sold its household appliance business to China’s Midea Group and its medical equipment business to Japan’s Canon.
It was fined a ¥7.4bn at the end of 2016 when Japanese regulators decided it had deceived investors with false financial statements.
Toshiba is now facing 20 lawsuits in Japan filed by banks, individuals, overseas investors and other parties seeking damages totalling ¥50bn.
Was that it? No, not at all, because Pandora’s box turned out to have a trapdoor to financial hell inside it, and the contents of that when unleashed were truly terrifying. This was Westinghouse Electric, and the earlier financial teeth that bit Toshiba’s senior management in the ass, turned out to be an amputation machine threatening to financially dismember the whole Toshiba corporation.
Back in January 2006, wanting to grow its nuclear power generation business, Toshiba had bought Westinghouse Electric from British Nuclear Fuels Ltd (BNFL) for $5 billion (£2.8 billion). It set about building nuclear power stations in the USA, with two in Georgia and two in Carolina, using fixed price contracts wth, for example, Georgia Power. Bad move.
In March 2011, a tsunami struck and devastated north east coastal Japan's and three reactors at the Fukushima No. 1 nuclear power plant were damaged and went into meltdown. This caused much stricter nuclear power station regulations, causing costs to rise.
Westinghouse found its US reactor building costs were also rising because it was constructing newer and more complicated reactors than before. The situation became financially perilous with incalculable liabilities. There were building delays as well and Westinghouse tried to get more direct control over the projects by buying contractor CB&I Stone & Webster in December 2015.
Although the projects were not even halfway done, Westinghouse management had to recognise massive cost overruns over several years. It was a calamity. When the horror story was realised at Toshiba CEO level, not even the auditors, PWC, could quantify the losses.
In February this year, Toshiba chairman Shigenori Shiga fell on his sword, with the company delaying an earnings report and then expecting a $6.3bn hit from losses at Westinghouse.
It was all over bar the shouting at Westinghouse, which filed for Chapter 11 bankruptcy protection in March, with projected annual Toshiba losses then reaching $9bn.
In the event Toshiba reported in April, without auditor approval, losses up to ¥1.01tn with shareholders’ equity being -¥620bn and Toshiba’s consolidated net assets being -¥340bn. It said its very survival was now at risk from this calamity.
Toshiba has since agreed to pay $3.68 billion toward the construction of the two reactors in Georgia and is talks over the South Carolina plant about a similar payment.
CEO Satoshi Tsunakawa and his management team have had to deal with this whole new crisis since last year, and the company is again attempting to sell off assets to stave off financial oblivion.
Their awesomely difficult job is to generate a financial parachute for Toshiba in mid-freefall asit plunges towards a horrible reckoning of reaping what its blinded Westinghouse beancounters seemingly sowed.
Memory Business sale
One of these assets put up for partial or total sale is the Memory Business, now up for auction, and for which Toshiba wants at least ¥2tn (c $18 billion, £14.1 billion).
It needs to come to a decision on the Memory Business sale by the end of the month for a shareholders’ meeting, and it should announce a winning bid on June 28 this year. The overall deal has to close by March 31, 2018, due to Tokyo Stock Exchange requirements.
There have been a couple of bidding rounds so far by several bid consortia with a constantly changing group of partners, and these include:
- Foxconn or Hon Hai, which is based in Taiwan and has much manufacturing in mainland China. It and its partners, reported to include Apple and Amazon, as well as three Japanese banks, are bidding up to 3 trillion yen. Dell and Kingston Technology are also in, reportedly.
- Broadcom has been reported to be bidding ¥2tn (c $18 billion, £14.1 billion) or more with private equity partners such as Silverlake and KKR.
- Japanese state-backed investment fund INCJ and others including, possibly, WDC, Bain and KKR, and bidding over ¥2tn (c $18 billion, £14.1 billion). WDC does not want to have Broadcom be its partner in the flash JV. Korean RAM/NAND chipmaker SK Hynix could be involved with this as could Bain Capital and other Japanese state funds and banks.
The Memory Business asset auction is complicated by (1) the need for speed to meet Tokyo Stock Exchange deadlines, and (2) a Japanese state wish that intellectual property and jobs don’t ultimately go to China - which wants to build its own solid state memory capability and avoid dependency on the west.
A third complicating factor is that whoever wins the bidding will probably have to face one or more anti-trust reviews.
This particularly affects WDC as it is already in the flash foundry business, and would likely facing time-consuming anti-competitive regulatory hurdles as its greater ownership of the Memory Business would reduce competition. Such regulatory hurdles would delay the sale and risk Toshiba not meeting financial deadlines in its re-capitalisation efforts.
So WDC is now proposing, it’s reported, to buy Memory Business debt and not an equity stake, in an attempt to sidestep anti-competition reviews.
WDC and arbitration
WDC’s attempt to buy the Memory business is also handicapped by its own debts, encountered from buying SanDisk last year, the SanDisk which, ironically, owned the share in the flash joint-venture now owned by WDC. This limits the amount of money it feels it can put in to a bid.
So it has attempted to delay and obstruct the auction by claiming the joint venture Ts and Cs give it the right to agree/veto any sale of Toshiba’s interest in the JV. Toshiba disagrees and WDC has taken it to an international arbitration court as the JV contract specifies in such situations. Such arbitration court proceedings could delay the closing of any deal beyond Toshiba’s deadlines.
Its latest legal move will dismay Toshiba, and inject doubt into the other parties' attempts to buy the Memory Business.
Stifel analyst and MD Aaron Rakers says WDC believes “this move will incentivise Toshiba to more fully engaging on a possible win/win outcome. W. Digital notes that it has submitted proposals to Toshiba that adequately meet their demands.”
Toshiba’s formal legal reply to WDC’s injunctive relief claim is expected by the end of June, with a counter-response by WDC after that.
A hearing on this is expected in mid-July, destroying Toshiba’s desire for winning bidder decision on June 28, unless it can somehow kick this legal sueball into touch. Of course, if it plays nice, as WDC might say, and agrees a bid with WDC taking part, then all the legal shenanigans will simply disappear.
Will Toshiba call or fold in this enormously high stakes corporate poker game? Does WDC hold all the aces or a measly pair? Is there a joker somewhere? Who the hell knows? We wait with bated breath for the game to come to a conclusion. ®