DB/Scribner - Seagate Technology Muddled and messy
In line revenue, but a miss on EPS; Guidance a negative surprise
STX reported a muddled and messy quarter, with combined revenue of $2.53B in
line with our estimate but EPS of $0.27 coming in lower than our $0.44 estimate.
STX standalone EPS missed by a nickel, while Maxtor (MXO) was even weaker.
The miss was attributed to lower utilization at both STX and MXO factories and to
more aggressive pricing. F1Q07 guidance of $2.65-$2.8B in revenue and EPS of
$0.16-$0.20 was roughly $0.20 to $0.25 lower than the Street expected. STX
maintained FY07 revenue guidance but took EPS down roughly $0.20.
September quarter could have some “kitchen sink” syndrome
We felt certain the third quarter would be the worst Q for STX as the company has
to bear the burden of a full quarter of under-utilized Maxtor facilities plus lower
utilization at Seagate facilities prior to the full transition of Maxtor products. In
addition, the $0.20 takedown in FY07 guidance is primarily reflected in the
September quarter, with STX expecting very solid results in the first half of CY07.
$2.5B buyback could add upside to our FY07 EPS
STX also announced a $2.5B share buyback authorization, which was much higher
than the $1B in share buyback we believe the Street was expecting. At a $20
share price, STX would be able to buy back 125M shares or roughly 20% of its
outstanding shares. If STX were to buyback all of the shares today, the buyback
would roughly add another $0.50 to our $1.95 FY07 EPS estimate.
Reducing price target to $28 from $33; Risk-reward favors upside
We have lowered our EPS estimates and taken our price target down to $28 from
$33, which is based on 14x our revised FY07 EPS of $1.95. On our CY07 EPS, STX
is currently trading at less than 8x, which is nearing trough multiples of 7x. Based
on CY07 EPS, our price target is a conservative 10x. We expect STX’s shares to
rally in C2H06 as investors shake off June Q concerns and new processors begin
to ramp in August, offsetting concerns about weak PC demand. STX is the market
share and technology leader and is the best positioned HDD manufacturer heading
into CY07. Risks to Seagate include misexecution integrating MXO, market share
losses, and misexecution ramping PMR-based drives.
Investment thesis
We felt certain it would be messy and it was. Seagate’s core business was roughly in line,
albeit a little light on the EPS line. The impact of Maxtor was more dilutive than we expected
due to inventory write-downs and under-utilized factories. Guidance for the September
quarter was a disappointment, but we expect Seagate is being overly conservative in a
quarter which most investors will heavily discount. We continue to expect Seagate’s shares
to rally in the second half, as demand picks up and as we begin to see more positive data
points on pricing and PC demand. The one comment that gives us pause is management’s
concern about continued aggressive price declines into the second half of the year. Seagate
is modeling 7% ASP declines Q/Q through-out FY07, which we view as conservative given an
improving demand outlook. However, we believe this will need to be monitored closely
through-out the second half.
Guidance and DB estimate revisions
Management guided F1Q07 revenue to a range $2.65-2.8B versus Street estimates of
$2.87B. Gross margin guidance for Seagate revenue was reduced to 21-22% versus long-
term guidance of 24-26%, with Maxtor revenue expected to have 0% gross margins (in line
with prior comments). Non-GAAP OpEx is expected to be roughly $400M. Management took
the tax rate up to 10% versus prior guidance of 5%, and suggested other income and
expense would offset income taxes. Management is modeling roughly 610M shares (does
not include any impact from buyback), resulting in a non-GAAP EPS range of $0.16-$0.20. On
a GAAP basis, EPS is expected to be $0.04-$0.08.
Management guided FY07 revenue to a range $11.8-$12.3B in line with prior guidance. OpEx
is expected to be around $1.5-$1.6B with management modeling a tax rate of 10%, higher
than prior guidance of 5%. At a share count of 613M, non-GAAP EPS is expected to be
$1.90-$2.00, lower than prior guidance of $2.06-$2.25 (also excludes any share buyback).
GAAP EPS is expected to be $1.58-$1.68. Capex is expected to be $1.3B.
We have reduced our EPS estimates for F1Q07 to $0.18 from $0.47 and taken our FY07 EPS
down to $1.95 from our prior $2.32. We have also reduced our FY08 EPS to $2.95 from
$2.98. In order to be conservative, our model does not include share buybacks. We have
tweaked our revenue estimates for FY07 down slightly to $11.39B from $11.42B and
weighted our revenue upside to the second half of FY07. We have also raised our FY08
revenue to $12.3B from $11.8B reflecting Seagate’s improved positioning in FY08.
Valuation
We have revised our price target to $28 from $33 which implies that Seagate trades at 14x
our revised FY07 EPS estimate of $1.95. On our CY07 EPS, STX is currently trading at less
than 8x, which is nearing trough multiples of 7x. Based on CY07 EPS, our price target is a
conservative 10x. Since its IPO, Seagate’s average FTM P/E has been 15x, with a median P/E
of 13x and a one standard deviation range of 7x-23x. Our 14x multiple is slightly higher than
our 13x multiple for Western Digital, as we expect Seagate to benefit from its technology
lead. Historically HDD stocks have traded together with a P/E range of roughly 8x-20x. We
rate Seagate’s shares a Buy.
Risks
The hard disk drive sector is inherently volatile and subject to market share battles and
aggressive price declines. While we believe market fundamentals are currently in check, a
decline in overall demand could lead to aggressive tactics by any one of the HDD vendors.
Risks include an unfavorable supply/demand environment and failure to achieve competitive
time-to-market or time-to-volume. Specific risks to Seagate include market share losses as a
result of the announced Maxtor merger, misexecution in its lines of business, and
misexecution in ramping its new PMR-based drives.
Figure 2: Detailed financial results versus DB estimates
($ millions except EPS data)
DB EstActual
Q-05A 4Q-06E % change4Q-06A % change
FY June4
Revenue
2,1792,52816%2,52916%
1,926 18%2,045 25%
Cost of Revenue1,639
Gross Profit54060211%484-10%
Product Development17122532%20319%
Marketing & Administration8712847%12645%
0 NA0 NA
Restructuring1
Total Operating Expenses25935336%32927%
Operating Income 281249-12%155-45%
EBITDA4024123%331-18%
Interest Income132162%2162%
Interest Expense(13)(11)-15%(10)-23%
Other, net105NA0NA
15 NA11 NA
Other income / (expense), net10
Pretax Income291264-9%166-43%
8 -28%14 27%
Taxes11
Net Income (Operations)280256-9%152-46%
S Operations (Diluted) $0.55 $0.44 $0.27
EP
-19% -51%
Avg. Shares (Diluted)51057713%56811%
Margins
Gross Margin24.8%23.8%19.1%
Operating Margin12.9%9.8%6.1%
EBITDA Margin18.4%16.3%13.1%
Pretax Margin13.4%10.4%6.6%
Tax Rate3.8%3.0%8.4%
Net Margin12.8%10.1%6.0%
Product Development / Sales7.8%8.9%8.0%
M&A / Sales4.0%5.1%5.0%
Total OpEx / Sales11.9%14.0%13.0%
Shipments (000s) 27,29534,048 33,620
Total Drive
25% 23%
Enterprise3,7313,8904%4,20013%
Desktop15,30920,60635%20,55034%
Consumer Electronics (3.5-inch)3,9223,9280%2,900-26%
Mobile2,0333,32463%3,39067%
Xbox units (2.5-inch)- 1,700NA2,180NA
1-inch Drives2,300600-74%400-83%
ASPs $79.83 $74.25 $75.22
-7% -6%
ASP Q/Q decline1.1%-4.5%-3.2%
Source: Deutsche Bank estimates and Company data
Figure 3: Seagate unit model
Includes MXO --->
FYE June F2005A F2006A F2007EF2008E
(Shipments in thousands) Year Year YearYear
1QA 2QA 3QA 4QA 1QE2QE3QE4QE
($ in Millions, except ASPs) Sep-05Dec-05Mar-06Jun-06 Sep-06Dec-06Mar-07Jun-07
Revenue from P&L
$7,553$2,088$2,300$2,289$2,529$9,206$2,750$3,040$2,820$2,780$11,390$12,300
7 $2,821$2,777 $11,386 $12,298
Revenue calc'd from shipments $2,751$3,03
Total Drive Shipments98,12926,83528,82029,45033,620118,72539,11043,31240,95940,446163,827188,096
Enterprise13,5263,0513,5383,5104,20014,2994,4804,8514,4304,65418,41519,676
Desktop62,18517,44318,85217,48020,55074,32523,78626,34625,02523,33798,494109,737
Consumer Electronics (3.5-inch)10,6052,6792,4302,4902,90010,4994,0183,9203,4504,39015,77817,780
Mobile5,7142,4122,9003,7703,39012,4723,9265,0955,0044,91518,94025,278
Xbox units (2.5-inch)- 250 300 1,500 2,1804,2302,5002,4502,4002,4009,75010,725
1.8-inch Drives- - - - - - - 2502503508503,300
1-inch Drives6,1001,0008007004002,9004004004004001,6001,600
$76.97 $77.81 $79.81 $77.72 $75.22 $77.54 $70.31 $70.19 $68.85 $68.73 $69.52 $65.39
ASPs
ASP Q/Q decline-2.5%2.6%-2.6%-3.2%-6.5%-0.2%-1.9%-0.2%
ASP Y/Y decline-1.9%0.7%-10.3%-5.9%
Y/Y Growth
Total Drive Shipments23.8%24.0%18.8%18.1%23.2%21.0%45.7%50.3%39.1%20.3%38.0%14.8%
Enterprise30.4%1.2%6.0%2.0%12.6%5.7%46.8%37.1%26.2%10.8%28.8%6.8%
Desktop5.4%16.2%15.5%12.5%34.2%19.5%36.4%39.8%43.2%13.6%32.5%11.4%
Consumer Electronics (3.5-inch)69.4%6.0%30.1%8.9%-26.1%-1.0%50.0%61.3%38.6%51.4%50.3%12.7%
Mobile57.6%256.3%135.8%112.5%66.7%118.3%62.8%75.7%32.7%45.0%51.9%33.5%
Xbox units (2.5-inch)NMNMNMNMNMNM900.0%716.7%60.0%10.1%130.5%10.0%
1.8-inch DrivesNMNMNMNMNMNMNMNMNMNMNM288.2%
1-inch DrivesNM150.0%-46.7%-63.2%-82.6%-52.5%-60.0%-50.0%-42.9%0.0%-44.8%0.0%
Q/Q Growth
Total Drive Shipments-1.7%7.4%2.2%14.2%16.3%10.7%-5.4%-1.3%
Enterprise-18.2%16.0%-0.8%19.7%6.7%8.3%-8.7%5.1%
Desktop13.9%8.1%-7.3%17.6%15.7%10.8%-5.0%-6.7%
Consumer Electronics (3.5-inch)-31.7%-9.3%2.5%16.5%38.6%-2.4%-12.0%27.2%
Mobile18.6%20.2%30.0%-10.1%15.8%29.8%-1.8%-1.8%
Xbox units (2.5-inch)NM20.0%400.0%45.3%14.7%-2.0%-2.0%0.0%
1.8-inch DrivesNMNMNMNMNMNM0.0%40.0%
1-inch Drives-56.5%-20.0%-12.5%-42.9%0.0%0.0%0.0%0.0%
Mix
Enterprise13.8%11.4%12.3%11.9%12.5%12.0%11.5%11.2%10.8%11.5%11.2%10.5%
Desktop63.4%65.0%65.4%59.4%61.1%62.6%60.8%60.8%61.1%57.7%60.1%58.3%
Consumer Electronics (3.5-inch)10.8%10.0%8.4%8.5%8.6%8.8%10.3%9.1%8.4%10.9%9.6%9.5%
Mobile5.8%9.0%10.1%12.8%10.1%10.5%10.0%11.8%12.2%12.2%11.6%13.4%
Xbox units (2.5-inch)0.0%0.9%1.0%5.1%6.5%3.6%6.4%5.7%5.9%5.9%6.0%5.7%
1.8-inch Drives0.0%0.0%0.0%0.0%0.0%0.0%0.0%0.6%0.6%0.9%0.5%1.8%
1-inch Drives6.2%3.7%2.8%2.4%1.2%2.4%1.0%0.9%1.0%1.0%1.0%0.9%
Figure 4: Seagate income statement
Includes stock option expense --->
Includes MXO --->
A F2006A F2007EF2008E
F2005
FYE June 1QA 2QA 3QA 4QA 1QE2QE3QE4QE
Year Year YearYear
($ in Millions, Except Per Share Data)
Sep-05Dec-05Mar-06Jun-06Sep-06Dec-06Mar-07Jun-07
Revenue7,553 2,088 2,300 2,289 2,529 9,206 2,750 3,040 2,820 2,780 11,390 12,300
Cost of Revenue5,887 1,553 1,709 1,733 2,045 7,040 2,239 2,329 2,095 2,071 8,734 9,142
Gross Profit1,666 535 591 556 484 2,166 512 711 725 709 2,657 3,158
Product Development650 180 199 195 203 777 271 234 210 204 919 885
Marketing & Administration308 86 108 108 126 428 132 122 105 101 460 438
Restructuring- 4 - - - 4 - -
270 307 303 329 1,209 403 356 315 305 1,379 1,323
Total Operating Expenses958
Operating Income 708 265 284 253 155 957 109 355 410 404 1,278 1,835
EBITDA1,174 402 433 403 331 1,569 289 545 610 618 2,062 2,700
Interest Income36 15 14 19 21 69 20 20 20 20 80 96
Interest Expense(48) (13) (11) (7) (10) (41) (9) (9) (9) (9) (36) (36)
Other, net18 5 4 12 - 21 - - - - - -
7 7 24 11 49 11 11 11 11 44 60
Other income / (expense), net6
Pretax Income714 272 291 277 166 1,006 120 366 421 415 1,322 1,895
0 4 3 14 21 12 37 42 41 132 95
Taxes25
Net Income (Operations)689 272 287 274 152 985 108 330 379 373 1,189 1,800
$1.37 $0.54 $0.57 $0.53 $0.27 $1.87 $0.18 $0.54 $0.62 $0.61 $1.95 $2.95
EPS Operations (Diluted)
Avg. Shares (Diluted)502 506 507 521 568 526 610 610 610 610 610 610
Margins
Gross Margin22.1%25.6%25.7%24.3%19.1%23.5%18.6%23.4%25.7%25.5%23.3%25.7%
Operating Margin9.4%12.7%12.3%11.1%6.1%10.4%3.9%11.7%14.5%14.5%11.2%14.9%
EBITDA Margin 15.5% 19.3% 18.8% 17.6% 13.1% 17.0% 10.5% 17.9% 21.6% 22.2% 18.1% 21.9%
Pretax Margin9.5%13.0%12.7%12.1%6.6%10.9%4.3%12.1%14.9%14.9%11.6%15.4%
Tax Rate3.5%0.0%1.4%1.1%8.4%2.1%10.0%10.0%10.0%10.0%10.0%5.0%
Net Margin9.1%13.0%12.5%12.0%6.0%10.7%3.9%10.8%13.4%13.4%10.4%14.6%
Product Development / Sales8.6%8.6%8.7%8.5%8.0%8.4%9.9%7.7%7.4%7.3%8.1%7.2%
M&A / Sales4.1%4.1%4.7%4.7%5.0% 4.6% 4.8% 4.0% 3.7% 3.6% 4.0% 3.6%
Total OpEx / Sales12.7%12.9%13.3%13.2%13.0%13.1%14.7%11.7%11.2%11.0%12.1%10.8%
Y/Y Growth
Revenue21.4%34.0%24.5%16.3%16.1%21.9%31.7%32.2%23.2%9.9%23.7%8.0%
Gross Profit14.2%98.9%55.5%16.6%-10.4%30.0%-4.4%20.4%30.3%46.5%22.6%18.9%
Operating Income46.9%516.3%93.2%6.8%-44.8%35.2%-59.1%25.1%62.0%160.6%33.5%43.6%
EBITDA 29.9% 157.7% 62.2% 15.5% -17.7% 33.6% -28.2% 25.9% 51.3% 86.7% 31.4% 31.0%
Pretax Income53.2%615.8%96.6%16.9%-43.0%40.9%-56.1%25.9%51.9%149.9%31.4%43.4%
Net Income55.9%655.6%99.3%19.7%-45.7%43.0%-60.5%14.9%38.2%145.7%20.7%51.4%
EPS (Diluted)54.6%637.6%96.6%16.4%-51.3%36.6%-67.2%-4.6%18.0%128.6%4.0%51.4%
Avg. Shares (Diluted)0.8%2.4%1.4%2.8%11.4%4.7%20.6%20.4%17.1%7.4%16.1%0.0%
Q/Q Growth
Revenue-4.2%10.2%-0.5%10.5%8.7%10.5%-7.2%-1.4%
Gross Profit-0.9%10.5%-5.9%-12.9%5.7%39.1%1.9%-2.2%
Operating Income-5.7%7.2%-10.9%-38.7%-30.0%227.5%15.3%-1.4%
EBITDA 0.0% 7.7% -6.9% -17.9% -12.8% 89.0% 11.8% 1.3%
Pretax Income-6.5%7.0%-4.8%-40.1%-28.0%206.6%14.8%-1.4%
Net Income-2.9%5.5%-4.5%-44.5%-29.2%206.6%14.8%-1.4%
EPS (Diluted)-2.1%5.3%-7.1%-49.1%-34.1%206.6%14.8%-1.4%
Avg. Shares (Diluted)-0.8%0.2%2.8%9.0%7.4%0.0%0.0%0.0%
CY Revenue8,536 10,608 11,835
CY EPS$2.10$1.51$2.73 |
