Here's a very good new for Qntm
interactive.wsj.com
November 18, 1997
Disk Drive Makers Look Cheap -- if You Dare
Lisa R. Goldbaum
Buy when there's blood on the streets.
How many times has portfolio manager Mark Mobius's famous
saying been repeated in recent weeks? It refers to his
philosophy of investing in emerging markets -- and lately
it's been applied to Asian stocks.
But why look for bloodshed thousands of miles away when
there's plenty of carnage right here at home?
Exhibit A: the manufacturers of disk drives, those hard
metallic disks that store massive amounts of data and
programs for personal computers. The stocks of the
industry's major players have been in virtual free-fall
for the past several months, while hoards of value seekers
have repeatedly been fooled into thinking the stocks
couldn't possibly drop any further.
But with shares of market leaders
Seagate Technology and Western
Digital now more than 50% off their 52-week highs and with
major player Quantum down over 30%, some industry experts
now believe this beleaguered industry's "Big Three" may
have finally hit bottom and could be attractive
investments. "There's clearly money to be made here;
somebody just has to let Wall Street know that," argues
John Monroe, disk drive analyst at Dataquest Inc. in San
Jose, CA.
"The [disk-drive] industry is worse than it was at this
time last year, but not as bad as it has been in past
years," Monroe points out. The industry historically has
been prone to overcapacity and near-suicidal price wars,
but over the last few years there's been talk that disk
drive makers had finally grown up. That's because the
industry has been consolidating, with major players
swallowing up smaller rivals -- such as the merger between
Seagate and Conner Peripherals in 1995 -- leaving only the
strongest left to battle each other. Recently, this has
muted the industry's traditionally cutthroat competition
and has produced greater pricing stability than in the
past.
Still, disk drives are hardly proprietary products -- to
say the least -- and relatively low barriers to entry have
allowed cash-rich powerhouses like IBM and Fujitsu to jump
in with both feet. The upshot: periodic capacity gluts as
vendors tried to rush products to market ahead of
competitors, particularly in the summer, the slowest
season for these firms. And, as night follows day,
overcapacity leads to price cutting. Meanwhile, the
continuing transition to drives that have ever-higher
capacity -- like the move from 1.7-gigabyte drives to
2-gigabyte drives that is taking place today -- puts an
additional strain on manufacturers, who need to gear up
for more advanced products while unloading the thoroughly
commoditized lower-end drives.
Though a familiar story to disk-drive makers,
this problem appears to be especially acute
this year, because the market leaders seem to have greatly
overestimated demand and overproduced even more than
usual, causing a throwback to the epic price wars of the
past. In an interview with Barron's Online, Western
Digital's chairman and CEO, Charles Haggerty, admitted as
much, claiming the industry made a "big miscalculation in
the supply/demand equation." Western Digital, which
recently warned investors that its fiscal second-quarter
earnings would fall well below analysts' expectations,
cited industrywide price cutting as the culprit.
Likewise, Seagate blamed its abysmal first quarter ended
October 3 -- in which it lost $0.98 per share compared
with a gain of $0.59 a year ago -- primarily on "intense
pricing pressure during the quarter and weakness in demand
for the company's high-performance products." That
weakness was caused by competitors moving in on Seagate's
turf.
All of this has caused horror on Wall Street, where these
stocks seem nearly universally hated -- a signal as clear
as a bell to contrarians. The few managers who admit
owning these stocks seem in genuine despair about them
(although Nicholas Moore of Franklin Templeton Group said
in this week's Plugged In column that there were
opportunities for bottom fishing in the group).
And indeed, things may be about to turn around for the
downtrodden sector. Dataquest's Monroe says that
consolidation in the industry, along with strengthening
demand, should improve fundamentals. And once the major
disk-drive manufacturers cut production to be more in line
with demand, prices can start rising again, which in turn
could boost their stock prices. That could happen sooner
than many expect. Western Digital's Haggerty claims that
disk-drive manufacturers already have cut back on
production by 17% this quarter, easing overcapacity
considerably.
Even struggling Seagate has reason to
be optimistic, its executives say.
Donald Waite, the company's CFO, believes that Seagate can
turn itself around by becoming the quickest to get
products to market in the desktop arena. (He claims that
the company is already the "time-to-market" leader in the
high-performance sector.) Why is that important? Since
disk drives very quickly become commodity products,
there's a narrow window of opportunity to lock in higher
margins at the very beginning of a product cycle.
And Dataquest's Moore says the companies can still make
money despite the growing popularity among consumers of
computers costing less than $1,000. The high end of the
business, which includes enterprise servers, mainframes
and the burgeoning workstation market, requires greater
and greater storage capacity as operating systems and
programs become more and more sophisticated. By focusing
on that market -- and on mobile computing, which also
sports higher margins -- disk-drive makers could offset
the shift to cheaper units at the low end.
For brave souls willing to stick a toe in these tumultuous
waters, analyst Mark Specker at Soundview Financial
believes Quantum is the way to go. He argues that Quantum
is better hedged against pricing pressures because of its
lucrative presence in tape storage, which is used to back
up data. The capacity, price and performance of Quantum's
digital linear tape product has made it a popular choice
for the booming Windows NT server market, and has given
Quantum a big chunk of the backup storage market, Specker
says.
Moreover, it's selling at an attractive multiple to
earnings. At Monday's closing price of 29 15/16, Quantum
is trading at about nine times First Call's analysts'
consensus earnings estimate of $3.29 per share per share
for the fiscal year ended March 1999 -- a big discount to
its expected earnings growth rate of 23% next year. Over
the long term its P/E is still well below First Call's
projected five-year median growth rate of 21%.
Of course, people who belly up to the bar on these stocks
can't expect a smooth ride. With disk drive makers, no one
ever said it was going to be easy.
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Still alive after my huge loss on qntm
Richard
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