WSJ Article: Disk-Drive Makers Recover
From Extended Downturn
By LEE GOMES
Staff Reporter of THE WALL STREET JOURNAL
Computer disk-drive makers are a cheery bunch these days, and it isn't just because of the December holidays. Rather, all the celebrating is a result of the $25 billion industry finally pulling out of one of the nastiest downturns in its long history of booms and busts.
"The recovery is real," said Barbara Nelson, vice president at Quantum Corp., a Milpitas, Calif., drive maker, in comments echoed by many competitors. "This quarter is the best one we've had all year. Demand is as strong as it's been in a long time."
Investors certainly think that the worst of the recent slump is over, as shares in disk-drive companies and their suppliers have risen sharply in the last two months, outpacing even the big gains among tech stocks generally.
Shares of industry leader Seagate Technology Inc., for example, were trading near $17 at the end of the summer; its shares have jumped about 80% since, closing Wednesday at $30.75, down $1.625 in composite trading on the New York Stock Exchange. Shares of Western Digital Corp., another drive maker, have nearly doubled in the same period, closing Wednesday at $15.25, down 50 cents on the Big Board.
In fact, some of the recent increases bring to mind the behavior of Internet stocks. Most notably, shares of Komag Inc., a San Jose, Calif., maker of the storage platters used inside drives, have quintupled since their $2 levels of late summer. Komag shares closed Wednesday at $10.6875, down 25 cents in Nasdaq Stock Market trading.
Of course, all of these stocks are still well off their all-time highs. Komag shares, for example, were around $33 in 1995, while Seagate's stock was above $50 just last year.
But those peaks came before a triple whammy hit the industry.
The sudden popularity of sub-$1,000 personal computers forced computer makers, the biggest customers for disk drives, to cut back on component costs as they struggled to maintain profit margins in the face of plummeting prices. As a result, they started buying less expensive drives.
At the same time, those same PC companies remade their manufacturing methods, adopting a just-in-time inventory system. That meant they stopped ordering additional drives while they whittled down their existing inventories.
Finally, new entrants flooded the market, especially at the profitable high end. These included not only Asian manufacturers, whose products became less expensive owing to currency fluctuations, but also International Business Machines Corp., whose disk-drive operation in San Jose mounted an ambitious expansion effort.
The end result was a decimation of both orders and prices, causing a flood of red ink at drive companies. Overall, drive shipments for this year should rise just 6% from 1997, a far cry from the 20% annual increases of recent years, said Dennis Waid, analyst with Peripheral Research Corp. in Santa Barbara, Calif. A spokesman for Western Digital, based in Irvine, Calif., said the company saw quarter-to-quarter price declines of nearly 15%, more than double its accustomed declines.
But demand is now starting to pick up as PC makers have completed the task of working through old inventories. Mr. Waid, for one, expects shipments to increase 12% next year. And drive makers have revamped operations and learned to deal with lower prices by slashing payrolls, shutting down some plants and tightening internal operations. They have also found new ways to innovate: Quantum, for example, pioneered a new quality-assurance program to keep customers happy.
Alexa McCloughan, who follows the industry for International Data Corp. in Framingham, Mass., said the overall restructuring at Seagate has been especially far-reaching.
Still, Seagate was one of the companies most affected by the downturn, and is coming out of this cycle with a diminished position compared with where it once was. For example, the Scotts Valley, Calif., company's overall market share at the start of last year was 25%, a full five percentage points ahead of No. 2 supplier Quantum. Now the two companies are in a virtual dead heat.
Seagate is still far ahead in revenue, owing to its strong position in the lucrative high end of the market. But even that is changing. Two years ago, the company had a 4-to-1 lead over its nearest rival, IBM. By next quarter, though, IDC is predicting Seagate's share of the high end will drop to just 44%, compared with IBM's 37%.
Indeed, analysts say that the surge by IBM has been one of the most striking changes to come over the industry in the past year. The computer giant once made disk drives mostly for its own use; now, more than half of its disk-drive units, valued at more than $1 billion a quarter, are sold to outside suppliers, said Greg Enriquez, vice president in the company's drive division.
But Steve Luczo, chief executive of Seagate, said that because of all the restructuring, his company is coming out of the downturn in a stronger position than when it entered it. With gross margins up sharply of late, "we think that long term, we'll have an even stronger business plan than we've ever had," he said.
Analysts agree that, over time, the industry can again see the sorts of profits it enjoyed two years ago. But some worry that investors, who have recently bid up the price of disk-drive stocks, may be getting ahead of events. While Western Digital's shares have doubled, for example, the company is still expected to post losses for another two quarters.
"There is a recovery going on, but this industry still remains very competitive," warns Paul Fox, analyst at NationsBanc Montgomery Securities.
For the long term, a key to making disk-drive makers healthier and less vulnerable to cyclical demand swings will be for them to find new markets outside of PCs. That already may be happening, as disk drives are starting to show up in all manner of devices. For instance, some high-end printers now ship with drives, for faster operations.
Drive makers also hope to find big future markets in a new breed of digital consumer devices, such as digital cameras and television set-top boxes.
Of course, to prosper in these new markets, the industry is going to have to avoid some bad old habits, especially the knee-jerk urge to cut prices when things get tough. "Anytime anyone gets profitable, they want more market share," said Finis Conner, an industry veteran who recently launched a new company aimed at the low end of the market. "People are going to need to resist that temptation."
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