The disk drive industry has always been one of those cyclical
tech sectors that's periodically flooded with overcapacity.
Inventories pile up and producers slash prices to clear them
It's a nasty business. But there is a solution: Buy out the
This is precisely what market leadersWestern Digital (
) andSeagate (
) have recently done. Late last year, Seagate purchased Samsung's
hard-drive business. In March, Western Digital completed a deal
to purchase Hitachi's hard-drive business for $3.9 billion in
cash plus 25 million shares.
Now sitting atop the computer-hard-drive storage market with
45% market share, Western Digital has begun to realize the
benefits of lessened competition.
In its fiscal fourth quarter of 2012, which ended in June, it
easily topped Street estimates. Revenue came in at $4.75 billion,
well above the consensus of $4.35 billion. Non-GAAP earnings of
$3.35 easily distanced analyst estimates of $2.39.
Pricing was relatively stable, perhaps the biggest factor in
the strong performance.
"The industry hasn't historically been able to hold the line
on pricing," noted Stifel Nicolaus analyst Aaron Rakers. But in
reducing the ranks of producers from five to three, Western
Digital and Seagate have shown "a willingness to maintain
pricing," said Rakers.
Also, more than willingness. Now they're showing the ability
to uphold prices. "The pricing environment has remained benign.
They're already benefiting from fewer competitors," Rakers
Western Digital's new pricing power represents a dramatic
reversal of historic trends, noted Jayson Noland, an analyst with
Robert Baird. Western Digital last quarter realized an average
selling price (
) of $65 on its drives. But way back in 2007-08, ASPs were in the
"mid to high 50s." he said. And in the past, the trend in drives
has been for diminishing prices.
"It's a reversal of historic trends in that ASPs have come up
as opposed to going down," said Noland.
Regulators fretted, but they did not block the Western Digital
buyout of Hitachi.
At the behest of Chinese regulators, Western Digital will
operate its legacy and Hitachi businesses as separate
subsidiaries for at least two years.
This will reduce any immediate synergistic financial benefits
that would come from slashing jobs or shuttering operations. U.S.
and European regulators required Western Digital to sell some
assets to Toshiba, the third and smallest surviving producer.
Meanwhile, the acquisition of Hitachi brings added benefits
beyond pricing power. Hitachi was a major player in what's called
enterprise storage. Enterprise storage customers include major
computer manufacturers. likeHP (
) andIBM (
), along with high-end storage array vendors likeEMC (EMC).
Enterprise disk drives are more profitable than PC hard
drives. It was an increase in enterprise sales that helped
Western Digital earn 31.8% margins last quarter.
In announcing strong fourth-quarter results in late July,
Chief Executive John Coyne also delivered a forecast that helped
push Western Digital shares higher.
"We believe Western Digital can deliver non-GAAP earnings per
share of $10 in fiscal 2013," said Coyne. He noted that in making
the projection, Western Digital took into account "a soft
macroeconomic environment." He assumed only a 5% rate of unit
growth in hard-drive demand.
But some analysts are more cautious in their outlooks. Robert
Baird analyst Noland believes Western Digital can reach its $10
earnings goal for 2013. But he thinks the company will have a
hard time staying at that level. With shares rising from near 32
to a recent 44 after the fourth-quarter report, Noland contends
most of the upside "has already been realized."
Even more skeptical is ThinkEquity analyst Rajesh Ghai.
Western Digital faces two threats, reasons Ghai. One, pricing
power may prove ephemeral. Toshiba is a distant third in the
hard-drive market, with a current share of 10% to 15%. But Ghai
expects Toshiba to substantially increase its production
This is precisely the sort of aggressive thrust for market
share that periodically sends drive prices tumbling. Competition
may have narrowed with the Seagate and Western Digital
acquisitions. But Toshiba remains a wild card.
The second threat is more fundamental. Ghai foresees a slowing
in PC sales.
And sales of drives for PCs represent the bulk of Western
Digital's unit sales.
He is skeptical the market will even grow by the modest 5%
that Western Digital executives forecast.
"The PC market in the developed world has been declining or
flattish. Emerging countries have driven the growth," said Ghai.
But he now expects PC growth to slow in emerging markets too.
"With the proliferation of tablets, the cannibalization of PCs
will spread to the developing world."
Mobile computing often relies on semiconductor memory, not
rotating hard drives.
The big question is how soon and how severely the shift to
mobile computing will threaten the hard-drive business.
Western Digital executives have argued that hard drives are by
no means doomed, noting that mobile computing may not use local
drive storage, but creates the need for external "cloud
So even as consumer use of hard drives erodes, massive
centralized storage needs to grow.
But Ghai believes hard-drive makers will lose in the
transition. He says, for example, that a PC user may have a
But music or photos stored in the cloud may go on much larger
3-terabyte drives. The drives, he explains, have six times the
capacity, but they don't produce six times the revenues. "Selling
a single terabyte drive does not earn the same profit as selling
six 5,000 gigabyte drives," said Ghai.
In a cyclical business that deals with memory, it's worth
remembering that the good times almost always come to an end.