ML: 12 Month Price Objective: $16
Investment Highlights:
· Disk drive stocks have been hammered due to
concerns about slowing PC revenue growth
and IBM's OEM deal with Dell. However, we
think the industry remains healthy and that
IBM is primarily focused on the high-end.
· We think Maxtor's transition to GMR
technology improves its outlook and increases
our confidence in our 1999 EPS estimate.
· We are upgrading the shares of Maxtor to an
intermediate-term Buy. The shares are
trading at a steep discount to our new price
objective of $16, or 16.7X our 1999 estimate.
Fundamental Highlights:
· Maxtor announced its DiamondMax Plus 5120
(7200 rpm) with next generation GMR head
technology, significantly improved density,
and higher throughput performance.
· We expect Maxtor to quickly ramp GMR
production due to its focus on time to volume
leadership and extensive development efforts.
· We are comfortable with our 1Q EPS estimate
of $0.17 on revenue of $697 million. Units
should be flat to up slightly with ASP erosion
in the mid-to-high single digits.
We think the carnage in the prices of disk drive stocks
is overdone. Concerns about slowing PC revenue growth
and IBM's $16 billion deal with Dell have hammered disk
drive stocks. Maxtor's shares are down by over 50% since
hitting its 52-week high in late January. However, we
think the industry remains fundamentally healthy, albeit off
to a slow start in 1Q due to a lull prior to Intel's Pentium
III introduction. Dell, IBM, and Compaq (Maxtor's three
largest customers) continue to grow much faster than the
industry and may become more aggressive on pricing due
to improved profitability. In addition, disk drive channel
inventories appear modest at about three weeks, we
estimate, down from over ten a year ago. We are
upgrading the shares of Maxtor to an intermediate-term
Buy from Accumulate. The shares are trading at a steep
discount to our new price objective of $16, or 16.7X our
1999 EPS estimate.
We are comfortable with our 1Q EPS estimate of $0.17
on revenue of $697 million. The company said that
shipments in 1Q were tracking expectations, including a
one-week halt in production in Singapore due to the
Chinese New Year. We expect unit shipments to be flat to
up slightly sequentially (versus a mid-single digit seasonal
decline for the industry). Shipments to recently signed
Hewlett-Packard (HWP, B-2-2-7, $68 3/8) and Gateway
are ramping conservatively, as expected. We expect ASP
erosion in the mid-to-high single digits sequentially due to
increased competition in the 4.3GB-per-disk segment. We
expect the DiamondMax 4320 to represent well over 50%
of shipments in 1Q. We are hearing that other desktop
drive suppliers are looking for modest ASP erosion due to
product mix. We hear that Compaq (CPQ, B-3-1-7, $34
3/4) has a long-term target for Maxtor's proportion of its
requirements that is lower than its current run rate. We
think this has put some downward pressure on the shares.
In late February, Maxtor agreed to buy a 350,000 square-foot
building in Singapore, which should provide sufficient
expansion potential for the next two years. The purchase
of the modestly priced building does not change the
company's cell-based manufacturing approach in which
capacity is added incrementally. We think this purchase is
strategically located near existing facilities and indicates
management's confidence in its outlook.
Maxtor is upgrading its disk drives with GMR
technology, significantly improving density and
throughput performance. Next-generation Giant
Magneto-Resistive (GMR) head technology significantly
improves areal density and throughput performance due to
greater sensitivity to magnetic fields from the disk.
Sensitivity of GMR sensors has more than twice the
sensitivity of MR heads, making it possible to detect
smaller recorded bits and to read these bits at higher data
rates. The company announced its 7200 rpm DiamondMax
Plus 5120 with GMR (code-named Nova), an upgrade to
its 2500. The company expects the DiamondMax 2500 to
grow to 1/3 of total shipments by year-end. We expect the
company to upgrade its flagship 5400 rpm DiamondMax
4320 (code-named Meteor) in mid-1999 with volumes
ramping in 3Q.
We expect Maxtor to quickly ramp production due to
(i) its focus on time to volume leadership, (ii) extensive
development efforts, and (iii) common manufacturing
processes. Maxtor typically announces products only
when they are ready to ship and is known for quickly
ramping production thereafter. For example, the company
shipped 1.7 million DiamondMax 4320 drives (21% of
total shipments) in 4Q after announcing the product on
10/1/98. Maxtor has been working on GMR technology in
conjunction with its suppliers for about two years. We
think Maxtor's manufacturing and integration experience
in MR technology is largely applicable to GMR given that
a majority of the manufacturing processes and testing tools
are common to both technologies. Maxtor requires first
pass yields of at least 85% before going into volume
manufacturing, which forces design discipline and
improves product performance.
We think Maxtor is at the front of the pack in bringing
GMR to the desktop. GMR disk drives have already been
introduced by IBM (IBM, B-1-1-7, $179) and Fujitsu, but
have been primarily used in servers, mobiles, and high
performance PCs. Western Digital has announced GMR
disk drives (WD Expert and WDC Caviar) through its
OEM agreement with IBM, but has not significantly
ramped production. Read-Rite, a supplier to Maxtor,
believes that it has closed the gap in GMR technology with
IBM, which had gotten an early lead. Read-Rite expects
GMR heads to make up between 5% and 10% of its
product mix in 2Q and 80% by year-end. Seagate and
Quantum primarily manufacture their own heads, but are
beginning to consider outside bids from GMR suppliers,
like Read-Rite. We expect Seagate and Quantum to ramp
volume production of GMR disk drives in 2H/99.
Why invest in a disk drive company? We think the
following factors are the most pertinent considerations:
· Healthy PC Demand. We think PC demand remains
healthy, albeit off to a slow start in 1Q, based on sales
out data and checks with Compaq, Dell, IBM, and
Hewlett-Packard. We estimate that unit growth was
about 43% for both IBM and Compaq; and 56% for
Dell in 4Q/98. We think that Y2K will provide some
incremental demand for PCs and disk drives in 1999.
· Increasing Market Share. Maxtor's penetration of PC
OEMs is growing, having signed 9 of the top 10. Dell,
Compaq, IBM, and Hewlett-Packard continue to gain
market share. The company began shipping to
recently signed Hewlett-Packard, the fourth largest PC
OEM, in January and is in the final stages of
qualification with Apple Computer.
· Low Channel Inventories. Channel inventories remain
prudent following the Christmas selling season, which
should keep the pricing environment favorable. We
think inventories are 3 to 4 weeks, down from double
digits a year ago. Major vendors have transitioned to
just in time inventory policies. Vendors are also
focusing on sales out rather than sales in, through their
rebate programs, salesforce compensation plans, and
advertising efforts.
· Rapid Product Introductions. Maxtor has been quick
introducing new products and beat the competition
transitioning to MR technology. The company plans
to continue to refresh products six months after
introduction to keep them competitive. The company
has been quiet about its activities on GMR technology,
preferring to announce products only when they are
ready for shipment, but has been working on GMR for
quite some time. The company plans to select three
GMR head suppliers (IBM is in the running). We
expect the company to upgrade its DiamondMax 4320
(5400 rpm) with GMR technology in late 2Q.
· Focus. Maxtor's focus on disk drives for desktop PCs
has been key to its success. The company plans to
continue focusing on this profitable and rapidly
growing segment. We expect the company to continue
reducing the cost of its disk drives, which should
increase their attractiveness in the entry-level PC
market. We expect the company to introduce a
Windows NT server disk drive in late 2000.
· Manufacturing flexibility. Maxtor's cell-based
manufacturing and order fulfillment processes have
allowed the company to quickly ramp production
while efficiently utilizing assets. Maxtor currently has
85 cells or lines in place, each of which is able to
make a complete disk drive. This has resulted in 90-95%
asset utilization as the company has ramped
production. The company claims it can reconfigure
manufacturing lines within hours. The company
sources from five or six primary vendors to ensure
sufficient supply and goes to market with three.
· Strong Management. The management team of
Maxtor has an average of fifteen years of experience
with many coming from storage industry leader IBM.
President & CEO Michael Cannon has been
instrumental in turning the company around since he
joined in 1996. In addition, management has
significant stocks options, which should keep them
focused on growing revenue in a profitable fashion.
· Attractive Valuation. The shares look very attractive
at just under 10X our 1999 EPS estimate of $0.96.
We think the stock, which trades at a 20-25% discount
to Quantum and Seagate (based on consensus
estimates), could easily trade in-line. We think near
term visibility looks good and operating margin
comparisons become easier in 1H/99.
Why invest in a disk drive company? We think the
following factors are the most pertinent considerations:
· Healthy PC Demand. We think PC demand remains
healthy, albeit off to a slow start in 1Q, based on sales
out data and checks with Compaq, Dell, IBM, and
Hewlett-Packard. We estimate that unit growth was
about 43% for both IBM and Compaq; and 56% for
Dell in 4Q/98. We think that Y2K will provide some
incremental demand for PCs and disk drives in 1999.
· Increasing Market Share. Maxtor's penetration of PC
OEMs is growing, having signed 9 of the top 10. Dell,
Compaq, IBM, and Hewlett-Packard continue to gain
market share. The company began shipping to
recently signed Hewlett-Packard, the fourth largest PC
OEM, in January and is in the final stages of
qualification with Apple Computer.
· Low Channel Inventories. Channel inventories remain
prudent following the Christmas selling season, which
should keep the pricing environment favorable. We
think inventories are 3 to 4 weeks, down from double
digits a year ago. Major vendors have transitioned to
just in time inventory policies. Vendors are also
focusing on sales out rather than sales in, through their
rebate programs, salesforce compensation plans, and
advertising efforts.
· Rapid Product Introductions. Maxtor has been quick
introducing new products and beat the competition
transitioning to MR technology. The company plans
to continue to refresh products six months after
introduction to keep them competitive. The company
has been quiet about its activities on GMR technology,
preferring to announce products only when they are
ready for shipment, but has been working on GMR for
quite some time. The company plans to select three
GMR head suppliers (IBM is in the running). We
expect the company to upgrade its DiamondMax 4320
(5400 rpm) with GMR technology in late 2Q.
· Focus. Maxtor's focus on disk drives for desktop PCs
has been key to its success. The company plans to
continue focusing on this profitable and rapidly
growing segment. We expect the company to continue
reducing the cost of its disk drives, which should
increase their attractiveness in the entry-level PC
market. We expect the company to introduce a
Windows NT server disk drive in late 2000.
· Manufacturing flexibility. Maxtor's cell-based
manufacturing and order fulfillment processes have
allowed the company to quickly ramp production
while efficiently utilizing assets. Maxtor currently has
85 cells or lines in place, each of which is able to
make a complete disk drive. This has resulted in 90-95%
asset utilization as the company has ramped
production. The company claims it can reconfigure
manufacturing lines within hours. The company
sources from five or six primary vendors to ensure
sufficient supply and goes to market with three.
· Strong Management. The management team of
Maxtor has an average of fifteen years of experience
with many coming from storage industry leader IBM.
President & CEO Michael Cannon has been
instrumental in turning the company around since he
joined in 1996. In addition, management has
significant stocks options, which should keep them
focused on growing revenue in a profitable fashion.
· Attractive Valuation. The shares look very attractive
at just under 10X our 1999 EPS estimate of $0.96.
We think the stock, which trades at a 20-25% discount
to Quantum and Seagate (based on consensus
estimates), could easily trade in-line. We think near
term visibility looks good and operating margin
comparisons become easier in 1H/99.
~~~~~~~~~~~~~~~~~~~~~~~~
BTW, there are recent 7% MXTR converts (DECS) which are typically
shorted against to arbitrage risk. This seemes to have occured with
MXTR whose percent short interest has increased dramatically over the
last 2 months:
Month Shares Short Avg Daily Volume days to cover Ratio
02/99 1,780,932 2,721,985 0.65
01/99 250,155 1,292,555 0.19
12/98 33,798 1,238,848 0.03
My bet is that short interest into 3/99 initially rose, and that there
was some sell overhang by shorter term players on the recent secondary
equity offering.
Fwiw, here is the recent ML rec on the Maxtor DECS:
DECS Trust IV/Maxtor 7.0% Pfd.
Disk drive stocks have been “hammered” due to concerns about slowing
PC revenue growth and IBM's OEM deal with Dell. However, we think the
industry remains healthy. Further, IBM is primarily focused on the
high-end, whereas Maxtor is focused on the desktop. We think Maxtor's
(MXTR/$9; D-1-2-9) transition to GMR technology improves its outlook
and increases our confidence in our 1999 EPS estimate of $0.96. We are
upgrading the shares of Maxtor from Accumulate to an intermediate-term
Buy. The shares are trading at a steep discount to our new price
objective of $16, or 16.7X our 1999 estimate. (R. Hansen 3/8/99).
The Maxtor DECS are an attractive alternative to a direct investment
in the common, in our view, because of their discount valuation and
positive risk/reward ratio. Recently trading at $10 vs. 9-13/32 for
the common, the DECS were 10.5% cheap to theoretical value using
model inputs of 40% annualized stock volatility and a credit spread of
78 bps over the five year Treasury. Current yield is 9.1%. Our one
year total return projections are +20.4%/-14.7% in response to a price
change by the common of +/-25%. The DECS have a mandatory conversion
date of 2/15/02, at which time they will convert into between 0.8474
shares (MXTR at $15.34 or higher) and 1.0 share of common (MXTR at $13
or less). The DECS are not rated by the agencies and are non-callable
prior to their mandatory conversion date. |
