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Should Western Digital's Plant Closure Worry Seagate Technology Investors?

A dissolving hard drive

Seagate Technology (NASDAQ: STX) continues to surprise investors. On a one-year basis, shares of the hard disk drive (HDD) storage manufacturer have advanced 60%, quadrupling the 14% return of the greater S&P 500 . This return was on top of the 6% dividend yield the stock boasted at the time.

On the surface, it would appear the company received another dose of good news when competitor Western Digital (NASDAQ: WDC) announced it was scaling back HDD operations by closing a plant in Malaysia: "The company will decommission its HDD manufacturing facility in Petaling Jaya, Selangor, by the end of calendar 2019."

For Seagate investors, there are both opportunities and risks with this announcement.

A dissolving hard drive

Image source: Getty Images.

The shift from consumer HDDs to SSDs is increasing

While the Western Digital announcement initially appears to be good news for Seagate Technology, the reason for the closure -- lack of demand for the product -- certainly isn't:

The data technology industry is undergoing substantial change. This market transformation is driving increased adoption of SSDs [solid-state drives] and NAND flash in traditional HDD applications. The change has contributed to growth in SSD/NAND flash and declining long-term demand for client HDDs.

For those who follow the industry, this isn't surprising; it's part of a long-term shift away from HDD to SSDs in PCs and other computing devices. Although HDDs are cheaper per gigabyte -- $0.05 vs. $0.25 -- SSDs use less energy, have a smaller form factor, and boast faster processing times.

As the shift in consumer demand continues toward higher-end ultramobile laptop PCs and mobile devices like smartphones and tablets, SSDs continue to grow market share at the expense of HDD. After purchasing SanDisk for $19 billion , Western Digital entered into the SSD market to diversify away from HDD, while Seagate Technology remains fully tethered to the product: The percentage of revenue from HDDs is roughly half for Western Digital versus 90% for Seagate .

Why Seagate's investors don't seem to care

One group that doesn't appear to care about a declining product is Seagate's investors; as previously mentioned, shares of the company have greatly outpaced the greater market. On the other hand, Western Digital shares have fallen 17%. The reason is a fascinating combination of economics and expectations.

In response to declining HDD demand, many companies have either abandoned ( Samsung ) or significantly culled investment in (Western Digital) that market. This makes sense when you consider that HDD shipments are projected to decrease 5% per year for the next four years .

Although shipments are expected to decrease, total HDD capacity is robust due to the growth of data centers, which continue to use HDD storage. So Seagate now commands a significant portion of a growing industry, nearly by default. And the company is taking advantage by posting a 4% revenue gain this fiscal year, only its second such gain since fiscal 2012.

On the other hand, although SSD shipments are increasing, the market for them is becoming commoditized, with many entrants. In the first quarter it was reported that Western Digital/SanDisk had 15.4% of the total market, down from a 20.5% market share a year ago. Competition has been particularly fierce from Samsung and a resurgent Micron Technology , which hired many SanDisk execs post-acquisition.

Ironically, the expectations that existed a year or two ago have been now been flipped: Seagate is no longer a floundering-consumer-HDD story, but, for better or worse, its fate is now tied to the rapidly growing data center industry. Seagate investors (and prospective investors) should update their expectations accordingly. On the other hand, Western Digital shouldn't be so quick to go all in on SSD -- at least not at this time, with significant and growing demand for HDD in data centers.

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Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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