Kevin,
Thank you for the kind remarks. You will get no complaints from me about mixed metaphors as it would constitute the "pot calling the kettle black".<G>
I fear another shoe drop as well in this sector. It stands to reason that not all makers can stand on the capricious edge of unprofitable operations forever. But I still like Seagate and I will follow this post (below) with Morgan-Stanley's latest report resulting from a visit to SEG.
You are correct that compression will alter the landscape a bit. I use a lot of MP3 compression to load my music on my laptop so my hotels rooms don't seem so ominously quiet while I work. At 12:1 (128K bit stream - CD quality) it takes anywhere from 3-6 MBytes to store a tune. You are also right about Ultra DMA (IDE) crimping SCSI's style as Lawrence has also pointed out. I see no reason that Ultra DMA II won't do the same to the low end of the UltraII SCSI radar screen. If the average consumer understood Ultra DMA they might want to upgrade. It is magnificent in handling large file transfers and I am very happy with my IBM Travelstar 4.0 GB drive for that reason. I access a lot of data base stuff as well as graphic files for presentations etc. It is really a dream. The result is a lessening of rotational speed requirements thus a much cooler operating drive.
Incidentally, bought a bit more Seagate today. (See Gillian Munson, Morgan Stanley below - My favorite analyst on SEG)
best,
Stitch
Reprinted for personal use only:
- Late last week we visited with members of Seagate's (SEG, $22, Outperform, Target $35) management team, including Steve Luczo, Chairman, CEO, and COO; Charles Pope, CFO; and Don Waite, CAO. The focus of our discussion was SEG's turnaround efforts.
- We thought the meeting was positive and re-affirmed our thinking on the stock. There are no changes to our estimates or our Outperform recommendation.
- R&D/product development, recording head development and production, and semiconductors are currently SEG's most critical focus areas.
- The high-end disk drive business (54% of CQ2 revenue) continues to be healthy, aided by the availability of the Cuda 9GB LP and 18GB disk drives, and as SEG has been discussing for a number of quarters, a main goal is to improve time-to-market in the desktop disk drive market (35% of CQ2 revenue).
- Beyond disk drives, SEG's additional product lines and investments are key assets for the company and should be factored into the company's valuation over time as the company executes on turnaround efforts.
- The disk drive industry environment continues to be very difficult, with severe pricing pressure on the desktop and a somewhat less severe pricing environment in the enterprise business.
- We have no change to our view that the disk drive business is a tough place to compete and that from here it may increasingly be a "survival of the fittest" business (this is not to imply that the industry has been easy to date - it just appears to us to be getting even tougher from here).
- We left our meeting with SEG continuing to believe that this team can make the right moves for the company and its shares. While we still believe the turnaround will take time to play out, we do believe that the company has the opportunity to show a reduction in the rate of year-to-year revenue decline in CQ3, a Q/Q gross margin increase, and steady progress on moving to an improved longer-term position. We believe that while not without risk, SEG in the low $20s provides us with an interesting story.
- Our CQ3E EPS is $0.15 on revenue of $1.6B (down 16% Y/Y, up 1% Q/Q), gross margin of 19.3% (up 40 basis points Q/Q) and opex of $282MM or 18% of sales. The First Call mean is $0.16. Of course, CQ3 will be seasonal and as a result visibility into CQ3 will probably only be clear in late August to early September.
- As for valuation, we continue to believe that an appropriate price target is $35, or 18 times a stretch C1999E EPS of $1.90.
MORE DETAIL BY PRODUCT:
DISK DRIVES
We believe that SEG's HIGH-END DISK DRIVE sales (54% of CQ2 sales) are getting better, and profitability in this area is improving. The release of the Cuda 9GB LP and 18GB is helping performance and we believe that SEG is regaining momentum at critical high-end customers. SEG needs to keep on the pressure in this area as IBM has been aggressive over the course of the last year and Quantum (QNTM, $16, Neutral), Western Digital (WDC, $11, Neutral), and Fujitsu are all trying to gain market share.
In the DESKTOP DISK DRIVE BUSINESS (35% of CQ2 sales), we believe that SEG continues to have work ahead of it, but that management has laid the groundwork for positive change. The critical issue for SEG in its desktop business is to regain time-to-market performance (we suspect that the company could be as much as 5 months behind at the moment). Most importantly, it must align its product development teams to a platform approach (i.e. trying to better leverage each new design from the design before) and get to market faster and more efficiently. This includes improving the technology staging process, gaining ground in recording head development, and working through some semiconductor issues (there are roughly 7 functions that are run by semiconductors or combinations of semiconductors in a disk drive - interface, microprocessor, servo, motor, program manager, data buffer, & read channel - numerous companies provide semiconductor solutions to the disk drive market and SEG is trying to more efficiently design and source these solutions).
We believe that while SEG is still committed to vertical integration from a cost perspective, that the company has truly adopted a more efficient strategy of outsourcing some technology from independent suppliers of recording heads and leveraging its internal operations. By in essence pitting its internal recording head supply against external competition, SEG is trying to create a better sense of urgency internally. Already, SEG is seeing better time to market and improved efficiency in the recording head operation. In addition, the company believes that it is getting good products from its outside suppliers. Finally, where possible, SEG has pursued a strategy of sourcing HGAs (head gimble assemblies) and wafers instead of full HSAs (head stack assemblies) in order to utilize its own backend capability to build HSAs.
On an operations basis, SEG continues to have work to do. The disk drive factories are seeing improvements in yields and scrap, and SEG management continues to work to improve OEM and distribution relationships. We do not believe at this point that SEG will sell or close any more disk drive facilities. While improvements in productivity may make such a move possible, it is likely that the company will hold on to its facilities in order to enable it to respond if its product positioning drives additional demand over the next several quarters.
Other businesses and investments
The SOFTWARE BUSINESS continues to grow nicely for SEG and provide a positive gross margin boost. While on its CQ2 conference call, SEG indicated that it was slightly disappointed with software sales which were flat Q/Q but still up Y/Y to $79MM (up 41% Y/Y), the company was quite upbeat about the software operation in our discussions last week. In CQ2, sales were lower than expected in NSMG (Network and Storage Management Group - Backup Exec, Desktop Management Suite, NerveCenter, WinINSTALL, WinLAND) while IMG (Information Management Group, otherwise known as Business Intelligence - Crystal Reports, Crystal Info, and Holos) sales continued to be strong.
In TAPE (4% of CQ2 revenue), LTO (tape drive development with Hewlett-Packard [HWP, $52, Neutral, Covered by Tom Kraemer] and IBM [IBM, $127, Strong Buy, Target $145, Covered by Tom Kraemer]) progress continues to be on track. SEG hopes to have a demonstration of the technology available at Comdex (November). In the base tape business, the company was able to recognize improving gross margin in CQ2. While this is not a rapidly growing business, we believe improving profitability can still be positive as we await the release of LTO.
QUINTA is also moving along its development path and management indicated that it was pleased with progress at Quinta. In this area, SEG hopes to have a demonstration by Comdex. Importantly, SEG is using Quinta to drive advanced technology development for disk drives. While positioning of this strategy is still a bit unclear, it may mean that we won't see a product for the mass market for a couple years and instead, will see a larger contribution from Quinta in the way of the future product pipeline.
On the investment front, SEG continues to have a number of interesting activities. SEG owns 25% of SANDISK (worth $70MM given SanDisk's current stock price of $10). GADZOOX, which is a private Fibre Channel solutions company, is doing quite well. Finally, DRAGON SYSTEMS, a private speech recognition company is gaining additional attention. |
