I’ve been on the hunt for bargains lately. A company that recently stood out was Seagate Technology PLC (NASDAQ:STX). At a very superficial first glance, the company looks like a bargain. It trades at a P/E of under 5, with a forward P/E of about 6.7. It yields over 4%, which is awesome. But is this company truly a bargain, or is it a value trap– lagging the market for a reason? Let’s take a deeper look.
A duopolistic storage king
The company’s cheap valuation and high yield are positives initially. Nothing like buying a cheap stock and collecting a great stream of income, while waiting for the market to realize they left behind a good company. The company also has a large share of most of the markets it operates in. It also dominates in these saturated markets for the most part, with Western Digital Corp. (NASDAQ:WDC) usually being its sole competition.
Seagate Technology PLC (NASDAQ:STX) controls around an estimated 40% share of the hard-disk drive market, with competitor Western Digital owning another 45%. Being second, but by a long-shot compared to those below you in a saturated market, can often be a strength — as barriers to entry are high. So why not consider Western Digital Corp. (NASDAQ:WDC)? Because yielding only 2%, Western Digital Corp. (NASDAQ:WDC) makes me like Seagate Technology PLC (NASDAQ:STX) and its 4% dividend yield twice as much.
Falling knife or double-edged sword?
Seagate seems to be a very cyclical company, and a recession may mean a quick and sudden drop in already seemingly sporadic and unpredictable earnings. A global recovery and a pick-up in enterprise could also mean really good prospects for earnings, however, so know that Seagate Technology PLC (NASDAQ:STX) may be a double-edged sword.
Another thing to watch closely if considering an investment in Seagate is its balance sheet — as debt looks to be much higher than many other tech companies.
Is there a cloud over the moat?
Cloud computing needs storage. As a major player in a duopolistic storage market, a pick-up in enterprise data-centers and cloud computing may be the drawbridge that allows Seagate to cross its more PC-related moat to discover more growth, as well as new markets.
Seagate may make a good play on increasing cloud-related data storage, more so even than current leaders in the public cloud space, such as Amazon.com, Inc. (NASDAQ:AMZN), Google Inc (NASDAQ:GOOG), and Microsoft Corporation (NASDAQ:MSFT). All three of these cloud giants seem to be engaged in a price war.
While Amazon web services (AWS) is expected to double revenue this year (which also works out to be around 5% of sales), there is a problem. Amazon already had minuscule margins of only around 1.11% for 2012, as compared to over 25% for Google and Microsoft Corporation (NASDAQ:MSFT).
Bloomberg author Ari Levy thinks this is good, explaining that “Amazon can cut prices on cloud services without “affecting its total profitability” because “Investors aren’t fazed by Amazon.com, Inc. (NASDAQ:AMZN)’s low margins.” As Amazon’s stock continues to defy gravity and remain richly valued, even with negative earnings, Levy may have a point.
This is why Microsoft Corporation (NASDAQ:MSFT) and Google Inc (NASDAQ:GOOG), who are also increasingly beginning to battle over the enterprise apps markets (as Google is trying to eat some of Microsoft’s lucrative Office pie), may end up being dragged down and required to continue to lower their margins also — to compete with Amazon.com, Inc. (NASDAQ:AMZN).
Microsoft and Google Inc (NASDAQ:GOOG) need their cloud services as well, in order to tie in all of their components and products into one big succinct ecosystem. They don’t really have any other choice but to play ball. The cloud war seems to really be a series of battles as a result of a larger ecosystem war.
Seagate Technology PLC (NASDAQ:STX), as a data storage company, may be able to profit from the sidelines, and the cloud and the massive amount of data that will be generated (which also needs to be stored) could be a huge opportunity for growth. Seagate, as a leader in solid-state drives, also has a footprint in the mobile revolution, and is aggressively looking to increase its presence in things such as tablets.
But what if the cloud brings rain?
The cloud is a huge hope for growth. The major threat that now faces Seagate is a soft economy, or even a recession. If enterprise demand drops, so will Seagate’s profits. Luckily for Seagate Technology PLC (NASDAQ:STX), cloud computing may help them offset some of the soft environment that poses such a threat — or will it?
Another pressing concern with companies like Seagate, at least in the near-term, and what looks increasingly likely in the long-term as well, is the maturity of the PC market. While operating in a saturated and mature market can be great for a cigarette company, it can also be bad for a tech company who “misses the boat” for the next big thing.
Cigarettes are cigarettes — technology changes daily and eventually becomes obsolete: which is why Marlboros may be around forever, but many formerly dominant tech companies suddenly seem to drown in their own moat, leaving many investors scratching their heads. Seagate may be drowning in its own PC-related moat.
The bottom line
Although Seagate has a higher amount of debt than many other tech companies, it is also priced at an insultingly low 5 times earnings. The company will also pay you nicely — yielding over 4%. The company also faces major headwinds, however, on any weak economic data, as well as any bad PC news — such as the recent drop in PC sales reported by Gartner.
The bright side comes with a global recovery. If the global economy begins to improve, bringing enterprise demand right with it, Seagate will look much more attractive as a value play. Cloud computing and related increasing demand for remote storage is an opportunity, but it’s not so clear-cut as to whether Seagate Technology PLC (NASDAQ:STX) will be able to offset declining PC sales with cloud related revenue. Buy Seagate now as a speculative value play and for its yield, but don’t trust it completely as a long-term holding yet.
Joseph Harry owns shares of Microsoft. The Motley Fool recommends Amazon.com and Google. The Motley Fool owns shares of Amazon.com, Google, and Microsoft.
