Western Digital Clock Reset Shows Hurdles for Tsinghua Sale

  • Tsinghua deal refiled with national security review panel
  • CFIUS likely to decide whether it has jurisdiction next month

Western Digital Corp. has reset the clock for U.S. officials to review the hard-drive maker’s plan to sell a 15 percent stake to Tsinghua Unisplendour Corp., the latest indication that Chinese investors in American technology face a challenging path in winning national security approval.

Western Digital this month refiled its notice with the Committee on Foreign Investment in the U.S. about its $3.8 billion deal with Tsinghua, the company said in a regulatory filing dated Jan. 26. The sale would make Tsinghua, a business unit of China’s Tsinghua University, the largest single shareholder in Western Digital and give it a representative on the company’s board.

CFIUS is expected to decide by next month whether it has jurisdiction over the deal, according to the company, which withdrew its previous notice with CFIUS in November. If the committee decides it has jurisdiction, the review could last as long as 75 days, and Western Digital may be forced to undergo national security reviews for future deals in the U.S., according to the filing.

“We do not believe it is a covered transaction,” Chief Executive Officer Steve Milligan said Thursday on a conference call with analysts. “That being said, it’s up to the CFIUS committee and the U.S. government. Clearly we were very careful how we structured the transaction.”

The review comes amid heightened concern over Chinese investment in U.S. technology firms and China’s effort to build its own semiconductor know-how by acquiring American firms. Chinese investors today are undergoing the most CFIUS reviews and their interest in U.S. technology has drawn criticism from U.S. lawmakers worried about risks to national security. Growing concerns over intellectual property theft and cyber attacks also have fueled unease about Chinese acquisitions. Last year, the U.S. threatened sanctions against China if it didn’t do more to curb hacks against economic interests after officials pointed to China as the source of a hack into government personnel records.

CFIUS Discussions

Western Digital, based in Irvine, California, said in a statement that it’s still in discussions with CFIUS and declined to comment further.

CFIUS, which is led by the Treasury Department and includes the Defense and State departments, reviews acquisitions of U.S. businesses by foreign investors and can recommend the president block any transaction it deems could compromise national security. Companies generally abandon deals if CFIUS objections can’t be resolved.

Any calculation over Western Digital’s September plan to sell a stake to Tsinghua was made more complicated a month later, when Western Digital’s potential stable of intellectual property grew with a deal to buy SanDisk Corp., which makes flash memory chips.

The closing of the SanDisk acquisition isn’t contingent on approval for an completion of the Tsinghua investment, Milligan said. If his company doesn’t get the cash from China, it will issue more shares to SanDisk investors to pay for the transaction, he said.

“The only question is will the number of shares exceed 20 percent of our outstanding shares?” Milligan said. The company is confident it can win shareholder approval for such a scenario, he said.

The chips made by SanDisk are commodity-like storage semiconductors used in mobile devices and computers and are widely available from other suppliers. But the U.S. company is one of only a handful that’s developing leading-edge manufacturing capabilities. China currently doesn’t have direct access to such techniques and companies such as Intel Corp have been prevented from exporting it there.

‘Complicated Issues’

Even though Tsinghua is only buying a 15 percent stake in Western Digital, the deal can still come under CFIUS jurisdiction based on other governance rights it’s gaining in the transaction, said Anne Salladin, a lawyer at Stroock & Stroock & Lavan LLP in Washington who worked on CFIUS reviews while at the Treasury Department but isn’t involved in the Tsinghua transaction. If there is jurisdiction, the committee will probably be interested in reviewing both the Tsinghua investment and Western Digital’s purchase of SanDisk because of the technology involved and the investment from a Chinese buyer, she said.

"They present complicated issues," Salladin said about semiconductor deals. "If it’s technology that’s cutting-edge technology or proprietary, it’s more likely to receive a more in-depth review than technology that is ubiquitous."

Cleared Deals

CFIUS has cleared some investments in the semiconductor industry by Chinese parties, including Integrated Silicon Solution Inc.’s sale to Uphill Investment Co., and the purchase of OmniVision Technologies Inc. by a group composed of Hua Capital Management, Citic Capital Holdings and GoldStone Investment Co. Still, ISSI was forced to resubmit its notice to CFIUS before winning clearance after an in-depth review.

Earlier this month, Dutch company Royal Philips NV said it was canceling the sale of its lighting-components business to a Chinese-led consortium due to opposition from CFIUS. The sale stalled over the transfer of semiconductor technology involved in making LEDs, a device that emits light, one person familiar with the situation said last year. 

CFIUS, whose reviews are confidential even after they are completed, can impose conditions on transactions to address security concerns such as restricting non-U.S. citizens’ access to products and services.

Board Restrictions

The Tsinghua representative on Western Digital’s board would be restricted from participating in talks involving government contracts, sales or other sensitive matters, Western Digital said when it announced the deal in September.

China is making a concerted push to build its domestic chip production and lessen its dependence on foreign technology. China buys more than half the semiconductors sold each year, yet doesn’t have one domestic manufacturer among the 10 biggest chipmakers.

That sets up a challenge for CFIUS in balancing the need to protect against security risks from any one particular transaction without discouraging foreign investment in U.S. companies, said Mario Mancuso, a lawyer at Kirkland & Ellis LLP.

"It is absolutely the case that CFIUS and the broader U.S. national security community has serious concerns about China’s focus and strategy to acquire leading semiconductor technology in the United States, particularly because of the role that semiconductors play in modern military capabilities," Mancuso said. "That is not to say United States is closed to Chinese investment but with respect to certain crown jewels the U.S. is going to be very protective and will continue to be."

Western Digital’s Milligan said on Oct. 21 that he didn’t think the SanDisk takeover would affect the U.S. review of Tsinghua’s investment.

Plan B

If the deal is cleared, Tsinghua would gain its stake -- and Western Digital would have a $3.8 billion infusion -- just as Western Digital looks to close its $19 billion purchase of SanDisk. That acquisition would help Western Digital counter declining revenue as the market moves away from older hard disk drives.

Western Digital foresaw potential problems with closing the Tsinghua deal when it announced its acquisition of SanDisk on Oct. 21. At the time it included a Plan B: should the Chinese transaction unravel, Western Digital would pay more stock and less cash.

Rather than paying $85.10 per share in cash and 0.0176 shares of Western Digital stock, the cash portion would become $67.50, with 0.2387 shares of Western Digital stock, if the Tsinghua transaction hasn’t closed or has been terminated.

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