Legal fight between Toshiba and Western Digital could disrupt memory chip industry

An escalating legal fight between Toshiba Corp. and manufacturing partner Western Digital Corp. threatens to disrupt the chip business that both companies’ futures depend on.

The two will face off in a California court hearing Friday on Western Digital’s request for an order temporarily blocking the sale. The U.S. company is arguing that it has a say in the sale of Toshiba’s semiconductor operations, as well as right of first refusal. The Tokyo-based company disagrees, saying that Western Digital is overstating its rights.

Toshiba, which is seeking to sell its memory chip unit to make up for a multibillion-dollar writedown in its nuclear energy operations, clinched a preliminary agreement last month to sell the division to a group led by the Innovation Network Corp. of Japan, Bain Capital and other investors. The consortium of preferred bidders is offering 2.1 trillion yen ($19 billion), people with knowledge of the matter have said.

With the legal dispute dragging out, the companies are careening toward the worst possible outcome for both. Western Digital could lose access to memory chips from Toshiba, its most important product line, while Toshiba risks seeing its shares delisted if it can’t secure cash by the end of this fiscal year.

“Western Digital’s preferred outcome is probably to either buy out Toshiba completely or keep the status quo,” said Hideki Yasuda, an analyst at Ace Research Institute. “Western Digital has no flash technology of its own, if the joint venture breaks up, they are out in the cold.”

Sale Process

Toshiba said it intends to go ahead with the sale process. “Toshiba is confident it can move forward with the sale of the shares of Toshiba Memory Corp. and intends to do so, irrespective of Western Digital’s objections,” said Naomi Furuya, a spokeswoman for the company. “While the sale of the three joint venture entities is in dispute, Toshiba is confident it will prevail on that issue. Toshiba Memory Corp. is a separate entity from the three joint ventures.”

Western Digital representatives directed inquiries to comments made by the company’s Chief Executive Officer Steve Milligan during an earnings conference call late Thursday: “Our goal has always been to protect and preserve the health and future of our successful joint ventures.” The two sides had discussions in Japan last week which were “constructive, and we will continue to work to seek a solution that is in the best interests of all parties.”

A San Francisco state judge may rule on Western Digital’s injunction request as soon as Friday. Superior Court Judge Harold Kahn tentatively ruled late on Thursday that the court has the authority to consider Western Digital’s request, clearing up a legal point raised by Toshiba. The court’s decision will have no bearing on the outcome of the arbitration, which will proceed on a separate legal track and will ultimately determine which prevails.

Toshiba shares fell as much as 7.7 percent in Tokyo on Friday after the ruling.

Chip Disruption

If Toshiba is forced through arbitration to sell its stake in their venture to Western Digital, the move could trigger the dissolution of their legal partnership, according to regulatory filings. That would cancel the supply agreement under which the U.S. company gets chips and make it the owner of only some equipment, according to people close to Toshiba and the terms of their relationship. That equipment would be useless without other machinery and the plant itself, which would remain Toshiba’s property. Production of memory chips for Western Digital would stop, the people said.

Click here for an explanation of Toshiba’s financial dilemma

Another person close to Western Digital and familiar with the contracts between the two said that analysis is a misrepresentation of the arrangements. The joint venture unit has lease rights which would continue regardless, guaranteeing that Western Digital would continue to get chips, this person said. Such a fundamental breakdown in the relationship and pursuit of legal remedies to this kind of conclusion is unlikely, the person said.

Balance Sheet

The first scenario, if it plays out, could spell disaster for Western Digital, which spent $14 billion to acquire a stake in the joint venture through the acquisition of SanDisk Corp. in 2016. The flash memory chips that the factories in Japan produce are replacing the magnetic disk technology that Western Digital’s technology is based on. Rival Seagate Technology Plc showed the perils of trying to compete in storage without newer chip technology; earlier this week, its stock dropped 20 percent after earnings fell far short of estimates.

For Toshiba, further disruption of its attempts to find a buyer endangers the urgent task of repairing its balance sheet. The company is seeking to complete the chip sale by March to avoid delisting from the Tokyo Stock Exchange.

“If the case drags on and if the market price of the memory unit slips in the meantime, that would be no good,” said Hidetoshi Ohashi, chief credit strategist at Mizuho Securities. Toshiba needs help from banks to stay in business, and their “willingness to support it is largely dependent on how much the sale will generate,” he said.

Credit Impact

Credit analysts have been seeking to gauge the potential impact of the court telling Toshiba to hold off on the sale. Scenarios range from Western Digital getting hold of the chips business, to Toshiba filing for court protection to keep its memory technology at home, according to Nomura Securities. Ultimately, arbitrators will have the final say, said Toshihiro Uomoto, chief credit analyst at Nomura, who warned that the process could take a year or more. Each side will pick one arbitrator, with a third chosen jointly.

Addressing concerns in credit markets over the possibility of Toshiba filing for bankruptcy, Ohashi said that was unlikely because a negative ruling would effectively put Toshiba’s technologies up for grab for whoever is willing to pay the most.

In May, Western Digital invoked an arbitration clause in the business agreement, seeking to block Toshiba’s transfer of ownership of the unit to a separate legal entity in preparation for a sale. Toshiba, which has since reversed that transfer, then had its lawyers send a letter demanding that the U.S. company stop its “harassment” as it seeks to sell the business. All told, the two are involved in six different cases in the U.S. and Japan.

A negative ruling that pushes Toshiba into bankruptcy would also threaten the fate of two half-finished nuclear reactor projects in the U.S. that its Westinghouse Electric unit was contracted to build. In bankruptcy, Toshiba could end up rejecting obligations, including a $3.7 billion guarantee that Westinghouse owes to Southern Co., the owner of a nuclear project in Georgia, and a $2.2 billion guarantee to Scana Corp. and Santee Cooper, the owners of one in South Carolina.

“I don’t see this battle resolving any time soon, it’s still going to be a long process before anything gets decided,” said Kazunori Ito, an analyst at Morningstar Investment Service. “Both are at risk, but I think that Toshiba has more at stake.”

The case is SanDisk LLC v. Toshiba Corp, CGC17559555, California Superior Court, County of San Francisco.