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Western Digital Seems Extremely Cheap


Myth465

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MrB,

 

You make some good points.  I think we are in agreement then that the consumer market is going to dwindle but there will be some replacement by data centers for large corporations and cloud providers.  Google, probably one of the biggest purchasers, uses commodity computers so I am fairly certain they are using seagate or western digital, at least in some cases.

 

I am just not sure about the forecast of the demand growth for cloud storage, it is very hard to predict.  I just know personally, and from my experiences in IT, we really are getting to a point where we just don't need significant storage past 1 or 2 TB.  There are certainly some companies that can use it, oil and gas is frequently cited as a major consumer of "big data" but I am not sure it will fill the void.    I just can't make a good call on this as I don't know the exact rate that storage demand will increase at and at what point it the growth rate starts to slow down.  I do know that SSD GB / $ should keep growing at 40% per year.  If storage demand grows at 25% a year then SSD will take over the cloud, if storage grows at 60% a year then then HDD will stay very much in demand.  A bit of an oversimplification but that is what I am grappling with.    I just don't like the odds and I still have a hard time seeing the average consumer needing 10's of TB of cloud storage so I think growth will slow down at some point.

 

I would also say that your logic of looking at past results may not be valid in this case due to SSD just starting to get to a reasonable price point.    You really need a 250 GB + hard drive for someone to use SSD as their primary drive and until the last few months it was just a little too expensive.  We are not getting into the point where the uptake on those hard drives will really kick off.

 

Both STX/WDC just launched or it might be that WDC is about to launch 4T drives. Although people like hoarding the whole backup story is totally nuts. I generally save a tonne of information only to revisit most of it.....well never.

 

I think annual data volume is about 900 EB and the world is currently shipping enough EB storage (2.6) to back that up almost 3 times over. However, look at the attached digital footprint of an email. It's nuts! Correction: I read somewhere that there is enough storage capacity to back up everything on the Web, twice over. I cannot find the source though, so put a question mark over it.

However, the data from IDC suggests in 2012 2,600 EB of data is being created and total storage is 1,188EB. Also, what is important, as far as I understand it, is that the 2,600 EB is production/replication this year and 1,188EB is total storage capacity this year, not new storage capacity. Anyone...please correct me if this is wrong, but that is the way I read that data.

 

So maybe we all wake up and realize that maybe we are over doing this a bit or is it a case of...to paraphrase "nobody ever lost money by betting against the intelligence of the public"

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Six months ago our company started using SSDs for all new laptop and desktop computers.  Most company computers don't need large hard drives and the 128GB SSD is all that is needed in most cases.  Our SAN is still using hard drives as we await for better industry standards on supporting SSDs in SANs.

 

If the SSDs keep dropping in price like the past 2 years then the future is not bright for Seageate and WD.  I'd say that within 24 months most laptops will come standard with an SSD instead of a hard drive as the benefits are even greater with a probable device.  Our company is in the process of replacing the slow 5400rpm hard drives in most existing company laptops to SSDs, giving better battery life and an incredible performance boost.

 

Two months ago I bought a new PC for home and went with just SSD.  I am still using an external hard drive for backup and storage, but still fewer hard drives than I was using on my old system.  Hard Drives are not going away but I believe demand will start shrinking over the next 2 years.

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Tape "seems" to be a sideshow, but very interesting. It looks to be used mostly for "cold storage". So archive type data that does not need to accessed frequently. The growth in areal density for tape is actually significantly higher than HDD or SSD and the costs drastically lower. It underscores again that these technologies are complimentary rather than exclusive...well it's really a bit of both.

 

Revenue from tape is only about $0.7Bn or thereabouts and make up 5% of the storage market measured in EBs

 

Interesting. Could people backing up to cloud backup services that use tapes turn around the seemingly secular decline in tapes?

I came across this for tape info: http://www.insic.org/news/A&S%20Roadmap.pdf

 

Nice one..thanks for sharing.

I think people should be backing up to tape more. It is currently about 5% of the market and in volume market share seems to be growing about 1 percentage point per annum and to be conservative I think one should factor in that it will speed up. Growing at 1 percentage point per annum from 5% is not insignificant and the price of tape is very low. So I do think it is a threat. I looked into accessing that story before, but with less than $1Bn in revenue shared by the LTO consortium there is no way I could see to access that story from an investment point of view.

Happy to get some ideas though.

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Our company has been using LTO tapes for years now and have no plan on getting rid of it.  But LTO tape capacity and speed seem to be maxing out now so there will need to be a new technology advance soon.  For consumers an external hard drive is a good method for backups.

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I am not sure exactly what your point is, I assume it is fundamental performance, so I’m not sure the attached data speaks to your point. Please feel free to let me know if you meant something else.

I attached the gross margins, operating cash flows and sales over the long term. I think the trend is clearly still the same, more so for STX. However, WDC did experience significant weakness from 1998-2001, both operating cash flows and sales. STX stayed cash flow positive throughout the period, but both showed a significant slowdown in sales from 1997-2003/4.

I had a quick look at WDC’s 10k for 2000 and it suggests those losses were related to a major product recall, production costs which resulted in them moving production from Singapore to Malaysia and diworsification/botched acquisition of Connex in particular.

So not sure exactly what you are driving at and whether the above sheds light on that, but happy to explore.

On another note, I suppose the trick is to figure out how the rear-view mirror gives a sense of the road ahead for all those companies. For WDC/STX another concern is how much of that gross margin/general performance was driven by consolidation, which is now over. Will they play nice or is it a case of the big dogs staring each other down? The future could therefore look very different compared to the past for these two companies.

 

Hmm I guess I have some preconceived notions about the storage industry.

 

A- I thought that profits would have been really high during the tech bubble.  I guess I was wrong about that.

B- I don't see it as being a terrible industry, but I don't see it as being great.

There may be some survivorship bias in only looking at WDC and STX?

C- As to whether or not margins will stay high... I don't understand what industry dynamic would keep margins high.

I guess you believe in consolidation.  I try to keep my ear to the ground and the rise of SSDs really worry me so these stocks are not something I want to mess around with.

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@MrB: Let me make it clear first that I haven't really looked at the financials of WDC, nor do I exactly know how big the enterprise market is compared to the consumer market, and how much hdd's will be used in cloud based storage.

 

But one prediction that I do want to make: the relative number of hdd's (or gb's provided by hdd's) for consumer applications is probably insignificant in the year 2020 compared to the percentages today. The combination of consumers moving increasingly towards mobile hardware, and a superior product that is exponentially getting cheaper is really strong.

 

I also wouldn't put much weight in the paper about the bleak future for ssd's. There is almost always some kind of big issue that could become a problem some number of years down road in tech: so far these kind of problems are always solved. I also think that the fact that sdd's are technically more related to regular computer memory and processors is a plus. Some of the multibillion dollars of R&D that is done in those industries will provide a tailwind for the technological advancements in flash memory as well.

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I do not see major barriers to entry in this industry. These guys are earning very high ROA (>15%) and ROE (>25%) even after you add back the writeoffs of goodwill. What could be the moat that is enabling these companies to earn such high ROA and ROE? If these rates of return could be sustained I would think many other competitors would jump into this.

 

The main barrier could ironically be due to the growth of SSD and expectation that HDD would decline. This would prevent competitors from making major investments in this industry and thus leave the field open to WDC/STX to milk it as long as they can.

 

Now that the industry has consolidated, assuming both of these guys act rationally (likely since they have seen the benefits of it) they might very well continue to earn high rates.

 

Any idea of why they have been able to maintain such high ROA/ROE in the past (2000-2007)? Are there some real barriers to entry?

 

Thanks

 

Vinod

 

 

 

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The moat is the sophistication of the devices.  HDDs are complex devices and with former national champions consolidated at this point the knowledge is in primarily 2 firms.  Thus I think the pricing will be better than in the past.  The other moat like characteristic is this is yesterday's technology (with a smaller portion of consumer devices) and thus will not attract folks who want to develop the next tech super company.

 

Packer 

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keep in mind the technology has to improve annually in order to stay in the game. Therefore a large amount of investment is needed is one start from scratch and is needed to be invested annually. The nature of the business presents great barrier to entry. Most likely over time they are going to be the only players.

 

Just thing through the set up you'll see how hard it will be. 

 

Mr.B On the PPT you posted it said that 60% of WD's production was down this year due to natural disaster. Dose it mean that WD will have significantly higher NI with and lower margins in the coming years or will it just be a larger pie ? OR will the industry be hurt by over capacity?

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@MrB: Let me make it clear first that I haven't really looked at the financials of WDC, nor do I exactly know how big the enterprise market is compared to the consumer market, and how much hdd's will be used in cloud based storage.

 

But one prediction that I do want to make: the relative number of hdd's (or gb's provided by hdd's) for consumer applications is probably insignificant in the year 2020 compared to the percentages today. The combination of consumers moving increasingly towards mobile hardware, and a superior product that is exponentially getting cheaper is really strong.

 

I also wouldn't put much weight in the paper about the bleak future for ssd's. There is almost always some kind of big issue that could become a problem some number of years down road in tech: so far these kind of problems are always solved. I also think that the fact that sdd's are technically more related to regular computer memory and processors is a plus. Some of the multibillion dollars of R&D that is done in those industries will provide a tailwind for the technological advancements in flash memory as well.

 

I don't dismiss what you are saying, I just want to see it in the facts, because I've turned a lot of corners with these companies only to find something totally different to what I was expecting.

 

On the point I highlighted--something that bothers me is that data production has been very strong over the last few years yet HDD growth has not been that strong. We could be at the inflection point where the slowdown in CE/PC is being picked up by enterprise, albeit slowly. Still trying to figure that one out.

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I do not see major barriers to entry in this industry. These guys are earning very high ROA (>15%) and ROE (>25%) even after you add back the writeoffs of goodwill. What could be the moat that is enabling these companies to earn such high ROA and ROE? If these rates of return could be sustained I would think many other competitors would jump into this.

 

The main barrier could ironically be due to the growth of SSD and expectation that HDD would decline. This would prevent competitors from making major investments in this industry and thus leave the field open to WDC/STX to milk it as long as they can.

 

Now that the industry has consolidated, assuming both of these guys act rationally (likely since they have seen the benefits of it) they might very well continue to earn high rates.

 

Any idea of why they have been able to maintain such high ROA/ROE in the past (2000-2007)? Are there some real barriers to entry?

 

Thanks

 

Vinod

I thought so to and have heard a lot of people say that. However, technology/patents, reliability (we're talking backing up your data here!), vertical integration and OEM relationships create more of a barrier to entry than people give the companies credit for.

 

Following on that an related to your ROE question. That competitive position gives them pricing power. Maybe it is really as simple as that. Everyone seems to be looking for something more complicated than that, but maybe it is just as simple as...they have pricing power and the proof is right there infront of us.

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The moat is the sophistication of the devices.  HDDs are complex devices and with former national champions consolidated at this point the knowledge is in primarily 2 firms.  Thus I think the pricing will be better than in the past.  The other moat like characteristic is this is yesterday's technology (with a smaller portion of consumer devices) and thus will not attract folks who want to develop the next tech super company.

 

Packer

 

And that is that as the wise man said...for all my searching and data gathering it pretty much comes down to what you said.

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The moat is the sophistication of the devices.  HDDs are complex devices and with former national champions consolidated at this point the knowledge is in primarily 2 firms.  Thus I think the pricing will be better than in the past.  The other moat like characteristic is this is yesterday's technology (with a smaller portion of consumer devices) and thus will not attract folks who want to develop the next tech super company.

 

Packer

+1

 

Just to add my two cents. I think people can recognize that the $/GB for HDDs will drop just as quickly as SSDs especially given the high fab costs/capex going forward for SSDs using under 22-nm transistors.

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I do not see major barriers to entry in this industry. These guys are earning very high ROA (>15%) and ROE (>25%) even after you add back the writeoffs of goodwill. What could be the moat that is enabling these companies to earn such high ROA and ROE? If these rates of return could be sustained I would think many other competitors would jump into this.

 

The main barrier could ironically be due to the growth of SSD and expectation that HDD would decline. This would prevent competitors from making major investments in this industry and thus leave the field open to WDC/STX to milk it as long as they can.

 

Now that the industry has consolidated, assuming both of these guys act rationally (likely since they have seen the benefits of it) they might very well continue to earn high rates.

 

Any idea of why they have been able to maintain such high ROA/ROE in the past (2000-2007)? Are there some real barriers to entry?

 

Thanks

 

Vinod

I thought so to and have heard a lot of people say that. However, technology/patents, reliability (we're talking backing up your data here!), vertical integration and OEM relationships create more of a barrier to entry than people give the companies credit for.

 

Following on that an related to your ROE question. That competitive position gives them pricing power. Maybe it is really as simple as that. Everyone seems to be looking for something more complicated than that, but maybe it is just as simple as...they have pricing power and the proof is right there infront of us.

 

You are probably right about the patents and OEM relationships creating some barrier to entry but they seem very similar to semiconductor memory makers where they do not have good profitability.

 

Thanks

 

Vinod

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The moat is the sophistication of the devices.  HDDs are complex devices and with former national champions consolidated at this point the knowledge is in primarily 2 firms.  Thus I think the pricing will be better than in the past.  The other moat like characteristic is this is yesterday's technology (with a smaller portion of consumer devices) and thus will not attract folks who want to develop the next tech super company.

 

Packer

 

Is it really that tough for a chinese firm to break into this say by buying Toshiba's HDD unit? You are right about this being yesterday's technology and it turning off potential competitors. But if they keep earning 30-40% ROE's I wonder how long it can continue without some competition.

 

Vinod

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The market for hard disks is shrinking and a new firm would need a decent share of the market to justify allocating a lot of capital today to acquiring technological knowledge, building a plant, marketing etc. How can a firm in a declining "commodity" business get market share? Probably by a price war, and then nobody will earn those nice margins anymore. That's the moat Packer is describing if I am correct. Right now Seagate and Western Digital have a tacit understanding; they are not lowering prices but are squeezing the last dollars out of a declining market. This is the best case scenario and if it works out WD could very well be a great investment.

 

Problem is that this equilibrium is not very stable, if either STX, WDC or a new competitor starts a price war then profitability will go down sharply. There is also the danger of HD's becoming obsolete within a couple of years.

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How can a firm in a declining "commodity" business get market share? Probably by a price war, and then nobody will earn those nice margins anymore.

In the history of commodity businesses, that has rarely (never?) been a moat.  People will enter the market anyways and engage in price wars.

 

Memory/RAM might be a good example.

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wrister is correct.  The devices are pretty sophisiticated as some people have tried to get into this market but it has been difficult due to supply chain issues and the perseption of a declining industry which keeps competitors away.  My sister is a supply chain person one of these cos and provided the supply chain insight.  Given the current price, the market doesn't think the market has changed and the HDDs margins will decline.  If they do not or not very far this will be a winner.  This is a higher risk bet than a bank or a TV firm but still a good bet in my book.

 

Packer

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To the bulls on HDD, what are your FCF projections for the future? On the surface of this this sounds good, a "commoditized" industry, however, nobody would really want to enter this space, so the scale players could really become good investments. This all makes sense, but is there a specific "turning point" that you're looking for that will unlock valuation?

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palantir,

 

for me this is more of a trading vehicle, usually buy when its hits 20's (lowe ideally) and sell when it hits 40's, while at the same time keep an eye out on the supply demand issue as well as SSD's progress etc.

 

i could be wrong on this maybe it will hit 50 or 60

 

PS: all above will change if something changes

 

hy

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