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Western Digital Seems Extremely Cheap


Myth465
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I saw WDC on one of my MFI screens yesterday and though I am not normally a tech investor, I am spending some time looking as well.  Companies that offer 40% trailing FCF/EV yield are usually reserved for businesses that are about to die.  Yes, SSD's will replace HDD's over time especially in portable devices.  But demand for storage is growing and has never been higher (think high res videos & photo's, databases, cloud technology, backup services, DVR's, etc.).  The key here seems to be that the market is not a zero-sum game.  Management sees demand for storage growing at 10-15% per year.

 

WDC doesn't appear to be in hospice.  They doubled their top line in the last 5 years and margins have never been higher.  Even then there is some additional margin of saftey with P/TBV of 130%, and no net debt. 

 

Aside from the fact that WDC is in a commodity business with no barriers to entry, a few other things temper my euthusiasm:

Lack of significant insider ownership (<1%)

Increasing share count over time

They are hoarding cash

Option issuance and lack of significant share repurchases/dividends

 

 

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My understanding is the cash is trapped abroad.

 

I think WD can buy there way into SSD, and I see the business as a Oligarchy type business. I don't think it is as commodity as most people think. You cant just tell Dell or HP you want to make HDDs. You dont have the name, relationship, or reliability to easily get into it.

 

As far as the shares issued, options, and low insider ownership - thats what would make this a value trade. I would sell at around $45 - $50.

 

My main issue is what do they do with the cash. They cant effectively repatriate it without having to pay taxes. So that eliminates dividends and buybacks. I would hope they would make a reasonable acquisition in Asia with the excess cash or perhaps buy there way into the SSD market. Either that or just let it pile up until something presents itself.

 

These two articles provided alot of color.

 

http://seekingalpha.com/article/217987-western-digital-seagate-technologies-questioning-the-outlook-of-the-hard-disk-industry

 

http://www.gurufocus.com/news.php?id=102514

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  • 5 months later...

Hey Myth, I stumbled upon WDC and have been taking a good look at it.  It is still cheap @~$30.  But, I'm trying to figure out why it's cheap.  What's your take on why WDC is unloved given its operating results are very good and balance sheet is strong?

 

In no particular order, I'm thinking:

--rise of mobile computing (smartphones and tablets) which use flash memory instead of hard drives.

--the related rise of cloud computing and online media streaming which allows for thin-client type PCs which may need less local storage.  Servers will need more storage, but those will be sold at lower margins.

--HDDs are very much like a commodity business, with modest barriers to entry and a history of technical disruption.

 

The flip side to those issues is the ability for individuals to create personal content that needs to be stored locally (home or office).  I know my personal need for storage has exploded recently as I take more pictures/and videos, store my MP3s, and set up a personal home media server.  I've gone from having maybe 100GB of storage in my home to having over TB of storage and looking to get more.  It seems like the demand for storage will continue to grow along with overall computing power. 

 

Thoughts?

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My thoughts are listed here and slightly in the LVLT 3 thread.

 

http://cornerofberkshireandfairfax.ca/forum/index.php?topic=3680.15

 

I was up 30% on this and am now down 3% due to holding 2013 leaps. Some smart guys who I like also own a good chuck. See Guru Focus. I bought first though lol. It rallied on a potential takeover for Seagate and a great Q4. Management has been issuing horrible guidance though due to oversupply (by competitors), and HP sucked wind on earnings / guidance and it tanked.

 

I have some options coming up (ATSG) which need to be rolled over or exercised and I am down to 4% cash. I plan to site down this weekend to sort out the options issue, and to hopefully raise some cash for more WDC. Its dirt cheap at something less than 5xCF when you take out the cash. I may not buy but its on the watch list for a potential purchase on a pullback.

 

Many people basically think smaller devices which dont have hard drives are the future. They also think SSD will kill the mature hdd market. WDC had a presentation and basically noted that every picture on facebook is stored on 6 hard disk drives around the world and maybe a bit more for redundancy. Devices drive data creation and data storage, and the "cloud" is realistically some dark room somewhere with thousands of hard drives. Traditional hard drives have the best price per gig and reliability and they bought an SSD company to move into that when it gets more mature.

 

I think its a fat pitch, and think people are a bit off base. Where do you think Netflix will store there library once they fully digitize it. How many copies of movies will they have to maintain for digital downloads. And finally what happens when everyone switches to HD and Blue Ray downloads?

 

Thats my 2 cents.

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Thanks Myth.  It's fair to say I basically see it the way you do.  And storage redundancy/backups is a great point I hadn't noted directly.  But, again from my own experience, I have a primary need for more personal storage for videos and pictures an whatnot.  But, I also have need of extra storage for backups.  That redundancy will probably have me doubling my personal storage in the next few months.  It's the same thing for businesses generally and for guys like netflix and google. 

 

 

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i have also been watching this area for a little while wdc, stx, sndk

 

i bought wdc back when it was 12 sold it in 30's i got back in again when it hit 25 (small position waiting to load up) or so. this is a very volatile area, both long and short term supply imbalances creates wild swings.

 

i also think the issue with ssd is over blown, wdc is completely aware of ssd and they are one of the best operators in this industry.

 

but i am still waiting since this area tend to have wild swings.

 

hy

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Thanks Myth.  It's fair to say I basically see it the way you do.  And storage redundancy/backups is a great point I hadn't noted directly.  But, again from my own experience, I have a primary need for more personal storage for videos and pictures an whatnot.  But, I also have need of extra storage for backups.  That redundancy will probably have me doubling my personal storage in the next few months.  It's the same thing for businesses generally and for guys like netflix and google. 

 

 

 

Hopefully the thesis plays out accordingly. Hyten is right this thing is quite volatile.

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Just to bring a different perspective.  Our company will be replacing the hardware that runs our ERP software.  Currently, we run 10+ fast SCSI drives in this system.  Our new hardware will not have any hard drives.  We are going with Enterprise SSDs for performance reasons.  We are also only a year or two away from considering Enterprise SSDs for our Network SAN.  Enterprise hard drives are the last domain for higher margin hard drives.

 

On a personal note I will be replacing my own home system in the next couple of months.  I will be going with an SSD for the OS and programs and then go with a cheap 5400rpm green hard drive for my other data.  These cheap drives have little to no margin.

 

Another trend is the continual movement towards smallers devices that depend on SSDs and memory for storage (ie. phones, tablets, etc).

 

The hard drive market is getting squeezed from all sides and I don't see this changing.

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Just to bring a different perspective.  Our company will be replacing the hardware that runs our ERP software.  Currently, we run 10+ fast SCSI drives in this system.  Our new hardware will not have any hard drives.  We are going with Enterprise SSDs for performance reasons.  We are also only a year or two away from considering Enterprise SSDs for our Network SAN.  Enterprise hard drives are the last domain for higher margin hard drives.

 

On a personal note I will be replacing my own home system in the next couple of months.  I will be going with an SSD for the OS and programs and then go with a cheap 5400rpm green hard drive for my other data.  These cheap drives have little to no margin.

 

Another trend is the continual movement towards smallers devices that depend on SSDs and memory for storage (ie. phones, tablets, etc).

 

The hard drive market is getting squeezed from all sides and I don't see this changing.

 

This is basically the short thesis cept short and sweet.

What are your thoughts on the overall growth of storage and hybrid drives?

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This is basically the short thesis cept short and sweet.

What are your thoughts on the overall growth of storage and hybrid drives?

 

I don't think the Cloud will increase hard drive use, just a shift in usage.  Most people only use a fraction of the hard drive in their system now and most of that due to Windows by default reserving 12% of the disk for restores (120GB on a 1TB drive) when only 10GB is really needed.

 

Hybrid drives won't succeed.  What happens if either the SDD or Hard drive fails.  The Enterprise will definitely not use this and the desktop/notebook market share will be decreasing in the coming years.

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SSDs have the problem that you can write to them only a limited number of times. Their performance deteriorates after a lot of writes and they need to be replaced. Although they don't have moving mechanical parts - thus reducing one class of errors, there are other issues that one must consider.

 

This has been way overblown.  Here is one reviewer who used his own system to see how long it would last.

 

http://www.anandtech.com/show/4159/ocz-vertex-3-pro-preview-the-first-sf2500-ssd/2

 

"Over this period of time I used only 10 cycles of flash (it was a 120GB drive) out of a minimum of 3000 available p/e cycles. In eight months I only used 1/300th of the lifespan of the drive."

 

 

Our company will be using IBM Enterprise SSDs.  IBM has rated them for 5+ years in intensive write environments running 7x24.  In most business environments IBM expect them to last much longer.  Based on my experience with hard drives, it looks like SSD have already surpassed hard drives for reliability.

 

 

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SSDs have the problem that you can write to them only a limited number of times. Their performance deteriorates after a lot of writes and they need to be replaced. Although they don't have moving mechanical parts - thus reducing one class of errors, there are other issues that one must consider.

 

This has been way overblown.  Here is one reviewer who used his own system to see how long it would last.

 

http://www.anandtech.com/show/4159/ocz-vertex-3-pro-preview-the-first-sf2500-ssd/2

 

"Over this period of time I used only 10 cycles of flash (it was a 120GB drive) out of a minimum of 3000 available p/e cycles. In eight months I only used 1/300th of the lifespan of the drive."

 

 

Our company will be using IBM Enterprise SSDs.  IBM has rated them for 5+ years in intensive write environments running 7x24.  In most business environments IBM expect them to last much longer.  Based on my experience with hard drives, it looks like SSD have already surpassed hard drives for reliability.

 

 

 

Thanks the detail Hoodlum. I guess now is a good chance for anyone to get out with a pretty nice gain. They have finally solved the cash problem. I like the deal so far. This gets us into Enterprise and SSD. It also takes a player out of the market. Its turning into a Duopoly.

 

http://www.hitachi.us/about/press/details/11162010.html

 

I think SSD will eventually take over, but also believe the key HDD players will be key players there as well when the time is right. WDC on the last presentation mentioned that Hybrid will only work if the operating systems are optimized. I do disagree with you on data. Its growing by leaps and bounds both via the consumer space (pics, music, movie downloads) and via the digitization and storage of existing data (government files, movies (these will have to be stored several times over to make streaming effective).

 

Basically I think these guys are in the storage / media business and not the HDD business.

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I've been looking at the numbers for WDC and Hitachi GST and I'm starting to think the combined entity should be worth $45 per share (probably more because I think WDC was worth close to $40 on its own). 

 

There isn't a lot of data on GST's financials, but the little comparative graphic that WDC put out with their announcement points to GST being around 60% in volume/revenue of WDC.  So, the combined entity probably had revenues of around $16 billion last year.  At the time of the announcement, WDC was trading at $30 per share which works out to about .7 x sales.  And, the $4.3 billion price tag for GST is probably around the same multiple of sales ($4.3 billion / $6 billion).  So, combined revenue of $16 billion at .7 x sales = $11.2 billion or $43.92 per share.  If the combination canibalizes 10% of sales, you're still north of $40 per share.

 

Alternately, if WDC and Hitachi think GST (which is around 60% of the size of WDC in units and revenues) is worth 4.3 billion, a comparable valuation for WDC would be $7.1 billion (4.3/.6).  The combined valuation would be $11.4 billion, or $44.70 per share.

 

I really think WDC management has managed to turn a couple billion dollars of excess capital into a dominant position in the hard drive market (with a little help from borrowing and share issuance).

http://www.wdc.com/wdproducts/library/company/investor/InvestorSummary.pdf

 

I had started buying WDC just before the announcement at around $30.  The immediate price jump on the announcement gave me a little pause, but I'm coming around to the idea that I can buy more at current prices and still get a decent deal.

 

Anyone take profits Monday/Tuesday?

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  • 1 month later...

Gentlemen we have a duopoly. Customers are determined to ensure there is a competitor so I am sure market share will be within a 40% - 60% percentage for both groups. 2011 will be the year of digestion, 2012 the year of integration, and hopefully by Dec 2012 we start the reward phase. Looks like I will have to hold onto my Leaps.

 

Value investors seem to be lining up and down the space. A good chunk own WDC and another chunk owns Seagate.

 

http://www.ocbj.com/news/2011/apr/19/report-seagate-eyes-samsung-unit-pending-western-d/

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The good news about the Seagate deal is Seagate gets SSD technology with the Samsung deal and the only 3 players left in the HDD space are Seagate, WDC and Toshiba.  Does anyone know if WDC is going to get a discount on purchase price due to the earthquake?  TIA.

 

Packer

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  • 2 months later...

For some reason there's been a radio silence about WDC in the past few months. We used to hear more about them in the past.. Myth, do you still have your position? Here's their Q4:

 

http://www.prnewswire.com/news-releases/wd-announces-q4-revenue-of-24-billion-and-net-income-of-158-million-or-067-per-share-125973023.html

 

For the quarter, revenue totaled $2.4 billion, net income was $158 million, or $0.67 per share, and hard-drive unit shipments were 54 million. The quarterly results included total expenses of $35 million associated with the planned acquisition of Hitachi Global Storage Technologies (Hitachi GST) announced Mar. 7, 2011, and for unrelated litigation accruals. Excluding these expenses, non-GAAP net income was $193 million or $0.81 per share.(1)

 

In the year-ago quarter, the company reported revenue of $2.38 billion, net income of $265 million, or $1.13 per share, and shipped 50 million hard drives. The 2010 results included $27 million of expenses related to litigation accruals. Excluding these expenses, the year-ago quarter non-GAAP net income was $292 million, or $1.24 per share.(2)

The company generated $447 million in cash from operations during the June quarter, ending with total cash and cash equivalents of $3.5 billion.

 

For fiscal year 2011, the company posted revenue of $9.53 billion and net income of $726 million, or $3.09 per share, compared to fiscal 2010 revenue of $9.85 billion and net income of $1.38 billion, or $5.93 per share. The 2011 net income included total expenses of $44 million associated with the planned acquisition of Hitachi GST and unrelated litigation accruals. Excluding these expenses, fiscal 2011 non-GAAP net income was $770 million or $3.28 per share.(1) The 2010 net income included $27 million of expenses related to litigation accruals. Excluding these expenses, fiscal 2010 non-GAAP net income was $1.41 billion, or $6.05 per share.(2)

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I'm not Myth, but my perspective on WDC hasn't changed.  I did lighten up a little bit back in May, just to get it back to a normal full position size for me.  The quarter/FY results didn't change much for me.  They seem to be outperforming Seagate for the time being.  I'm mostly waiting to see how the Hitachi integration progresses and how the HDD market holds up going forward. Recent tech results indicate that enterprise IT spending is strong which is helping offset tablet canibalization of PC/laptop sales.

 

Need to read the CC transcript still, but I don't think that will change my mind significantly.

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It's not as screamingly cheap as last September (when it was left for dead by Mr. Market), but with continued growing demand for storage, and the improved competitive position due to WDC's taking of market share (now 33% vs. 23% in 1Q 2008) there is still much promise.  Add in the potential for improved margins once the Hitacchi acquisition is complete in Q4 and I'd peg their (non pro-forma) FCF in the $850mm area, or 15% to current TEV of $5.6bln.  And there is 7% top line growth potential on top of that:

 

http://www.storagenewsletter.com/news/marketreport/hdd-industry-needs-transform-idc

 

I think management here is doing a great job operationally, competitively, and with capital allocation.  They maintained a debt free BS and took out a significant rival competitor when they had the chance in Hitacchi, and now they are left with basically STX as the competition.  I'd prefer to see a shrinking share base, but as long as they run the business well I can live with 1%-2% annual dilution.

 

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Good discussion with Seagate CEO Steve Luczo from Forbes:

 

http://www.forbes.com/sites/ericsavitz/2012/04/12/seagate-ceo-luczo-on-drives-zettabytes-flash-and-his-tattoo/

 

It's a long interview, but worth the read.  A couple snippets . . .

 

On how well financial markets value businesses:

Q: So, Steve, will that give the Street more respect for what you do? Drive companies historically trade at some of the lowest P/Es in the entire stock market.

 

A: Investors don’t fundamentally understand what we do. They tend to think, if things are bad, that’s how they’re going to stay, and if things are good, they’re going to get bad. That’s really been the philosophy. The glass is either half-empty, or its empty. Do I think that’s going to change? I don’t know. There are other big successful technology companies where you scratch your head and say why are they trading at an 8 P/E. Why is Microsoft trading at an 8 P/E? Why is Intel trading at an 8 P/E? I think a lot of it is a different discussion entirely, which is do our capital markets fairly value companies anymore fundamentally, and I’ll tell you my answer is no.

 

Q: Why not?

 

A: Because they’re not being price on fundamentals, they’re being priced by the large investment banks for volume. And volume requires volatility. So that’s why all the big firms are in a different camp than the smaller research firms on their perspective of the drive industry. Is it because these are the smart guys, and those aren’t? That doesn’t make any sense. It is because the big banks are motivated by volatility and the boutique firms aren’t. And therefore the research reflects that. So you can create an environment that always creates doubt, with billion dollar market cap swings in a week. It’s insane. Why does that work? Because you have traders who love to make that work. So do I think that changes? I don’t know that I see that changing for our equity markets in general, which is a terrible thing for the efficient allocation of capital. Does it change at the margin for the drive industry, if there is less volatility? Sure, I think it does. It takes time though. It’s going to take time.

 

On flash memory and the exploding need for storage:

Q: Let’s talk about the impact of flash memory on the drive industry.

 

A: Any analyst who is worrying about that fundamentally doesn’t understand the industry. Flash is a complimentary technology, it’s not a competitive technology.

 

Q: Intel is out pushing ultrabooks with all their might. Some have drives, and some of which don’t.

 

A: If you want to store anything on it, it will have a drive, or you are going to pay a lot of money for flash. I mean, yeah, if a bunch of rich people in Atherton want to buy a PC for $1,000 that has 128 gigs, then, sure. I just don’t think that is much of the world, and oh by the way, if they have that machine, they have some other machine somewhere that’s got 5 terabytes on it, because I can’t do much with 128 gigs. So those products that are built for speed and mobility, those still need support of mass storage somewhere. And oh by the way, most ultrabooks, or thin and light, which is a different term – ultrabook is an Intel marketing term, so hopefully you’ve received your check this week for using that term – those have certain requirements on performance, and certain budgets on price. And the right answer for that is probably going to be a hybrid drive, because that is the only thing that can get you the performance they’re asking for at the budget they’re asking for if you want any amount of storage capacity.

 

Q: Sitting someplace on a drive. So, demand for drive capacity will continue to grow.

 

A: Our industry shipped 100 exabytes of data five years ago, 400 exabytes in 2011, and we’ll probably ship a zettabyte sometime between 2015 and 2016. A zettabyte is equal to all the data that’s been digitized from 1957 through 2010. Everything, however you want to think of it, cards, tapes, PCs, mainframes, client/server, minicomputers – one zettabyte. And we’re going to ship that in one year. So whatever the architecture is, pads, phones, notebooks, ultrabooks, real notebooks, PCs, servers, clouds, one year, a zettabyte – that’s all going to be on rotating mass storage.

 

Q: And demand will keep ratcheting up from there.

 

A: By 2020, that number is somewhere between 7 and 35 zettabytes, depending on who you’re talking to – Seagate, which says 7, or EMC, which says 35. There is no amount of flash that can even address one tenth of one percent of that. People get locked in to this view at a device level. Yes, you could have some number of units that are serviced by flash. Let’s hope so. In fact, my bigger concern is that the flash guys can’t figure out how to keep delivering the performance and costs that they’ve been able to as they get to sub-21 nanometers, than it is that somehow they’re going to replace HDDs. Not without literally $500 billion of investment in fabs they’re not. And even then they’d only be scraping the surface.

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