Summary of disk drive outlook by Individual Investor (no new information, but reasonable summary of recent news)
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INDIVIDUAL INVESTOR ONLINE - Jun 8 11:40am
Industry Analysis
Jun 08, 1999
Computers: Why Seagate is the Best of the Disk Drive Makers
Analyst: Chris Bulkey (6/8/99)
Sub $1,000 PCs may be good for consumers, but they are causing a lot of pain within the
Hard Disk Drive (HDD) industry.
Last week, Quantum (NASDAQ:QNTM - news) , the number two HDD manufacturer,
announced that first quarter profit will fall short of analyst estimates. The company said earnings would be in the range of
$0.05-0.15 per share, well below the $0.31 First Call consensus.
The problem within the industry is not lack of demand, it is falling average selling prices (ASPs) and competitive pressures from
Seagate Technology's (NYSE:SEG - news) low-end U4 drive.
Management at Quantum claims that the rate of price declines was almost double that of previous quarters. As PC makers
demand cheaper components, the HDD makers are aggressively vying for sales. This all means the industry's outlook will
continue to be weak. Prudential analyst Kimberly Alexy sums up the fundamental outlook for the industry as "poor."
A big problem facing Quantum, Maxtor (NASDAQ:MXTR - news) and Western Digital (NYSE:WDC - news) is the success
of Seagate's U4 drive. Seagate has overhauled its manufacturing processes to enable the company to make this cheap drive at
a nice profit. Deutsche Bank Alex Brown analyst Michael Carboy estimates that Seagate can make this low end drive at a price
point in the mid $90 area, while generating a respectable 15-20% gross margin. The other three have been forced to lower
prices on their competitive offerings allowing them marginal profitability at best.
In this regard, Seagate seems to be the consensus favorite in terms of competitive positioning within this stagnant industry.
Although Seagate has had execution and time-to-market problems in the past, they are ahead of the curve in this product cycle.
Besides seeing strong demand for its highly successful U4 offering the company's enterprise (high-end) products are doing well,
which is helping to offset weakness in the desktop segment where over-capacity continues to be a problem.
One really need look no further than the recent estimate revisions to see which company has the toughest transition ahead.
Carboy is ahead of the other analysts in revising forecasts for the four major HDD makers. He cut his outlook for the June
quarter on Quantum by almost 70% to $0.10 per share, which mirrors management's guidance (see first paragraph).
Carboy expects Maxtor to fall below breakeven as a result of the recent decline in ASPs forecasting a $(0.09) per share loss
down from a $0.03 per share profit. The profit picture looks especially bleak for Western Digital, where he expects the
quarterly loss to expand to $(0.50) per share from $(0.43) per share.
Although the industry remains in terrible shape, Seagate and Quantum may offer some value. Near-term upside for the overall
industry, however, could be limited by continued ASP declines and earnings announcements from Maxtor and Western Digital
that will likely disappoint.
Seagate has positioned itself nicely, as the others will have to play catch up in terms of being able to offer cost-effective drives
that have enough capacity for PC makers. Quantum, while struggling to lower price points on its desktop drive offerings, has a
very healthy DLT (digital linear tape) storage business, which was strengthened with last year's acquisition of ATL Products.
Quantum's DLT drives are used in systems that back up corporate networks. With storage being a critical element of any
computer network the demand for these products should show no signs of abatement. Admittedly, Quantum has its work cut
out in the HDD segment, but the strong storage business adds some value to the depressed shares.
Although the HDD group as a whole has discounted earnings warnings and falling ASP trends, we do not think Maxtor or
Western Digital represent value at current levels. Maxtor has long been known for being the leader in providing high
performance drives for sophisticated PCs. With the market continuing to trend toward low cost drives, Maxtor will continue to
feel pressure until the company establishes an effective low cost platform.
Feedback from the analytic community suggests that Western Digital is gaining share with some OEM (original equipment
manufacturing) deals, but there is an absence of conviction regarding the company's ability to stem the ASP erosion.
Simply put, the four HDD stocks have discounted a tremendous amount of bad news. The problem with forecasting a bottom,
however, is that these negative trends show no signs of reversal. Although PC demand remains favorable, which is supported
by comments from Quantum's management as well as analysts, the demand for cheaper components is not stopping, and will
likely accelerate.
What this means is that HDD makers will have to respond by developing low cost drives that can be manufactured and sold at
consistent profitability levels. Seagate's lead in this area will make it increasingly difficult for the others to compete over the near
term.
Bottom Line:
Assuming it takes three to four quarters to execute such a transition, there is a lot of opportunity cost involved in buying at these
levels. For that reason we would avoid Maxtor and Western Digital. We see value in Seagate and Quantum, though we'd like
to warn investors that upside could be slow in developing as the industry shows no signs of a sustained upturn. Seagate was
recently quoted at $31.81.
Copyright © 1999 Individual Investor Online
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