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Western Digital (NASDAQ: WDC) shares are up more than 15% over the last couple of days after the HDD manufacturer announced that China's Tsinghua Holding Company’s Unisplendour, or simply Unis, will pay $92.50 per share (33% premium to Sept. 30^th close), for  a 15% stake, consisting of newly-issued Western Digital stock. Although such a huge new share offering would normally lead to a considerable selloff due to the attendant share dilution, WDC shares have been making strong gains because the deal involves a five-year lock-up on the shares, during which time Uni's stake in WDC is supposed to remain above 10% to guarantee a board seat for the Chinese company. The deal will raise $3.78 billion cash for WDC, which the company said ''will facilitate our growth as we look to capitalize on the many opportunities and changes within the global storage industry.''

Western Digital 5-Day Share Returns

Source: CNN Money

So what’s Western Digital’s game plan here? While WDC has over the years been making significant storage acquisitions, the company rarely issues new shares as part of a merger. The last time the company went down this road was back in 2011 when it acquired Hitachi Global Storage Technologies, or HGST, for $3.5 billion cash and $750 million worth of common shares. The Unis deal, therefore represents the largest share-for-merger deal for Western Digital.

Meanwhile, the storage industry was up strongly in sympathy with the WDC deal. Shares of Micron (NASDAQ:MU), the chip manufacturer that Tsinghua is interested in acquiring, are up 12% while shares of SanDisk (NASDAQ:SNDK), a major flash storage player, are up 18%. Interestingly, share of rival HDD maker, Seagate Technology (NASDAQ:STX), remained almost unchanged.

Upping the flash game

Although WDC was rather ambiguous and refused to let the cat out of the bag regarding why it is making such a large share offer deal, we can try and make some deductions. Companies often offer new equity when their debt obligations get out of hand and they find themselves paying too much debt interest, or when their free cash flow position deteriorates so much that they are unable to comfortably finance their operations. In the case of Western Digital, none of these possible scenarios seems to apply. The company's debt-to-equity ratio of 0.28 is much lower than the tech sector average of 0.44.

Meanwhile, although Western Digital’s free cash flow position has been going south, it’s still within healthy range. The company’s free cash flow reading of $1.63 billion is considerably lower than the company’s 3-year average of $2.24 billion, but still works out to a healthy free cash flow yield of 8.9%, well above the sector average of 6%.

While the above analysis is by no means comprehensive, it leads us to strongly suspect that Western Digital is probably lining up a major storage acquisition, or series of acquisitions. And, going by current industry trends, these acquisitions will most likely be in the flash storage industry. Western Digital’s HGST is ranked the third-largest flash storage manufacturer after Diablo and SanDisk. The market probably bears a similar sentiment which could be the reason why shares of SanDisk were up sharply after the WDC-Unis deal.

An Acquisition On The Anvil?

Western Digital could be looking to expand its flash portfolio to maintain its leadership against Seagate Technology. Seagate recently announced that it was looking to acquire hybrid flash manufacturer HILL for $694 million. The fact that Seagate is willing to pay a huge 88% premium for the company should give you an idea just how competitive the flash industry has become. It’s not clear whether Western Digital would be looking to buy a hybrid flash manufacturer or an all-flash manufacturer like Pure Storage (Pending: PSTG).

An acquisition in the all-flash manufacturing industry would probably make a lot of sense due to industry trends. As the ASPs of SSDs continues to fall, more organizations are opting for all-flash storage as opposed to hybrid storage. As a result, the all-flash industry is currently experiencing explosive growth. Pure Storage, the second-largest AFA manufacturer, saw its sales quadruple to $175 million in 2014 and expects sales to double in the current year. The downside of buying an AFA company is that it would likely not be cheap. Pure Storage sports a lofty valuation of more than 17x sales, with negative earnings. But perhaps Western Digital would be quite willing to pay such a price to shore up its contracting revenues.

Bottom Line

The huge new share offering by Western Digital points to a possible flash storage acquisition looming over the horizon. WDC has a pretty good track record of making sound acquisitions, with HGST being its finest to-date. Investors can only hope that the company continues this legacy.