Too bad I didn't get this posted yesterday!
I believe it's time once again to look at HTCH shares for the following reasons:
THE BIG PICTURE
-HTCH is the world's leading and most technologically advanced suspension company with approximately 70% of the world market. To put the situation in perspective, their competitors produce very few pico suspensions while the great majority of HTCH's are pico (as are all TSA). Future suspensions are becoming much more sophisticated which would benefit the technology leader even in the absence of strong patent protection. To quote from their current prospectus, "We developed our leadership position through substantial investment in
research, development and design activities coupled with significant investments
in proprietary manufacturing equipment and production capacity. We have
maintained this position through multiple technology transitions in the disk
drive industry over the past decade, including the transition from thin-film
inductive recording heads to magneto-resistive ("MR") and giant
magneto-resistive ("GMR") recording heads, and the transition from micro- to
nano-to pico-sized recording heads."
-Everyone is moving to wireless suspensions very rapidly. HTCH essentially owns the TSA wireless suspension technology which all of their competitors are trying to incorporate into their products through integration of an expensive ($.60 to .80), high margin TSA flexure PURCHASED from HTCH.
- HTCH's actions in terms of continuing to invest massively in still further TSA capacity (with an objective of 10 to 12 million TSA per week by the end of September 1999), indicates their confidence that TSA will take the lion's share of the wireless market, becoming the industry standard.
-HTCH has strong patent protection on microactuation which is regarded as essential to meeting areal density demands several years down the road. Production issues to produce these suspensions are dramatically less than TSA.
-These factors have to make the business very unattractive for the competition especially in light of the increasing levels of investment required.
-Valuations of drive companies have increased with p/e ratios of around 20 based on current estimates. The industry continues to be extremely competitve and pricing pressures are intense. In contrast, HTCHs products are highly proprietary and show a degree of domination exhibited by only a few companies in the hardware business. Yet, HTCH trades at about twenty-two times December quarter's earnings annualized and a much lower multiple of future earnings.
-HTCH is one of the few companies which are virtually certain to experience rising ASPs, efficiencies, gross margins, revenues and profits sequentially in the coming quarters.
-TSA gross margins appear to have risen by over 30 percent last quarter and, still, there remains room for dramatic increases in output per production unit. The projected improvement in TSA margins of only several percent this quarter seems dubious in the face of such rapid increases in TSA output this quarter. (Incremental output may yield about 70% incremental profit). To quote from Hutchinson's current prospectus, "Because our business is capital intensive and requires a high level of fixed costs, gross margins are also extremely sensitive to changes in volume. Small variations in capacity utilization or manufacturing yields generally have a significant impact on gross margins."
-Perhaps most importantly, I believe we are rapidly headed into a world where the internet is ubiquitous and virtually everyone will have one or more PC type devices. Analysts are increasingly suggesting that investors look to internet infrastructure plays since internet companies are exorbitantly priced. With HTCH suspensions in probably 90% plus of high end disk drives (the front end of the internet) and probably 50 percent of the world's PC's (the back end), HTCH may be one of the cheapest internet stocks on the planet.
-The future of digital set top boxes and VCRs represents incredible upside not yet factored into disk drive stocks.
THE LITTLE PICTURE
-HTCH has clearly overcome TSA production problems and is now ramping very rapidly with current production already up to 5.5 mil TSA per week vs the December quarter's 4.3 mil.
-HTCH became cash flow positive last quarter despite $35 mil cap x.
-HTCH stock has been a laggard lately, probably in the face of the secondary offering due Feb 3rd which I understand is oversubscribed (I was told I might get under half the shares requested).
-Of the wireless suspensions, only TSA has proven itself so far (other than Fujitsu's internal production which may be inherently expensive). FSA will likely get some business (the industry would love a second source), but does not appear to be a product of choice.
Also on the very important point of TSA verses FSA, I believe we need to make sure that we're comparing apples to apples. Innovex's comparisons did not since they began with the unrealistic assumption of a $.50 base suspension cost.
Hutchinson: Hutchinson's current average TSA selling prices include not only their base suspension prices, but a number of significant extra cost at add-ons, some of which have of a great deal of value to the customer, as well as low-volume penalties which are being incorporated into the average selling price figures because so many suspensions are still in early production. For a good comparison versus Innovex, we should use a basic, bare bones pico suspension which sells for about $.75 in volume. Hutchinson is talking about a TSA premium of about one-third for a suspension in high volume. This would put their selling price for a bare bones TSA suspension in high volume at approximately $1.
Innovex: Has stated that they expect to sell FSA suspension for about a dollar of which approximately 50¢ is the premium for the flex circuit and installation. This implies a basic suspension price of 50¢. Unfortunately, for Innovex's comparison, Hutchinson's average pico selling price is approximately 75. I think it is safe to say that all customers is in this business are very sophisticated and that Innovex will pay the going rate for a base pico suspension. In other words if Magnacomp or HTCH will sell a suspension for 75¢ to Seagate, I would expect that that would be exactly the price which Innovex would pay.
So on the issue of the incremental costs to make a FSA pico, low-end suspension: Innovex starts with a $.75 basic pico suspension. Add the $.35 to $.45 flex circit (based on current selling prices in volume). Now add its installation, testing, adjustment, YIELD LOSSES, MORE YIELD LOSSES, shipping and handling, HANDLING LOSSES, etc. Now maybe add a little profit margin for this installation which is so difficult that no customer other than SEG will attempt to perform. Somehow, the cost advantage cited by INVX seems unattainable and is probably quite a large cost disadvantage. And at the end of the day you have a product which is generally regarded as inferior.
DISCLAIMER AND DISCLOSURE
All information presented herein is based upon financial information and SEC filings available from the company (10K, 10Q, annual reports, press releases, etc.) and upon discussions with company management. All information presented is accurate to the best of my knowledge, but cannot be guaranteed against errors or omissions.
Z Analyzer is long Hutchinson shares and options. These positions may be increased or decreased at any time without advance notice.
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