Gartner recently said in a report that all connected devices (i.e. PCs, tablets and mobile phones) are expected to grow 9% this year to 2.4 billion units, but also mentioned that the mix is changing. It is a well known fact that there is an increasing shift in consumer preferences towards smartphones and tablets leading to a decline in PC shipments; as per Gartner, it is expected to decline by 7.6% in 2013. As a result, the traditional hard disk drive (HDD) market is also experiencing a decline. Market research firm iSuppli stated that HDD shipments fell to 135.8 million units, down 2.4% from 139.2 million units in 3Q12. This brings the spotlight to two key companies in the storage sector Western Digital Corp. (NASDAQ:WDC) and Seagate Technology PLC (NASDAQ:STX).
To combat this increasing competition and to combat the declining sales in its HDD market, both the companies are increasingly focusing on their Solid State Hybrid Drives or SSHDs. Furthermore, both these companies have recently made strategic investments to help strengthen their product portfolio. I have provided a snippet on both these initiatives.
Hybrid Drives
Seagate has introduced its third-generation SSHD and the Seagate Laptop SSHD. Western Digital introduced a new line of SSHD Black “hybrid hard drives” that have a thickness of just 5 mm, which will be easier to use in ultrabooks.
One may argue that this is a solution for the declining HDD market, but the question still remains about the rising mobile market. These hybrids seem to be a temporary solution but are not game-changing solutions and, moreover, with the lower demand in Microsoft’s new Windows, there is still a threat with respect to the demand for these SSHDs.
However, the space on a smartphone or on a tablet is much smaller compared to a PC. Hence, while users may not be purchasing new PCs, there is definitely a demand for external hard drives, which is a convenient way to backup large data.
Further, as cloud-based storage devices gain importance, there will be a shift from local servers to cloud servers. Both companies are trying to gain market share in this space: Seagate Technology PLC (NASDAQ:STX) is manufacturing SSD and hybrid devices (Hard Disk + on-board NAND Flash) and has a target that 85% of its products will be hybrid devices by 2017. Western Digital Corp. (NASDAQ:WDC)’s subsidiary HGST is expected to release its helium-filled hard drives in 2013, which will not only run efficiently but will also be cooler.
Strategic Investments
Gartner estimates that companies will spend $4.5 billion on solid-state drives, which offer quick and energy-efficient performance, in 2015, up from just under $1 billion in 2010. And this is further corroborated by Western Digital and Seagate’s recent investments in Skyera and Virident respectively.
In March 2013, Western Digital’s investment arm invested $51 million in enterprise solid-state storage system Skyera. For Skyera this is its second round of financing from Western Digital. Western Digital previously funded Skyera as an outside investor. Western Digital Corp. (NASDAQ:WDC) president and CEO Steve Milligan said in the press release that it sees these strategic relationships as a way to develop highly optimized storage solutions to meet changing data management needs and sees Skyera as a company that provides exciting storage opportunities to combat emerging storage challenges.
Similarly, in January 2013, Seagate Technology PLC (NASDAQ:STX) invested $40 million in Virident, a startup focused on Flash storage. Seagate will offer Virident’s flash-PCIe storage products and will also gain a board seat; Virident will be able to take advantage of Seagate’s ample marketing and distribution channels.
Competition
Western Digital and Seagate are at loggerheads in this space and control over 90% of the market. In the last quarter, Western Digital was the market leader in desktop HDD, selling 59.2 million units versus Seagate’s 57.6 million units. This is the first time that Western Digital has been able to dethrone Seagate, as it benefited from the decline in demand for Seagate’s products due to higher pricing. However, despite its number 1 position, Western Digital’s total number of units declined 5.2% versus the previous quarter as compared to Seagate Technology PLC (NASDAQ:STX)’s 1.5% increase in the same period.
Both companies have reported their results. Western Digital Corp. (NASDAQ:WDC) surprised the market, beating consensus estimates by 14% to report 2Q EPS of $2.09. Further, its total shipments increased by a whopping 108% with revenues increasing 90% to $3.8 billion. Its enterprise segment increased 10% due to strong growth in cloud-based applications.
Seagate announced results above its guidance. It reported 2Q EPS of $1.28 versus analyst expectations of $1.38. Revenue was higher due to higher price points and a favorable mix with the enterprise segment having a higher share. However, the company has guided for a weak third-quarter with revenue of $3.25 to $3.45 billion, below consensus expectations of $3.49 billion.
These two companies are facing tough competition from SanDisk Corporation (NASDAQ:SNDK), which is the global leader in flash memory storage technology and is the most preferred brand in NAND chips for mobile devices. In 4Q it beat estimates but its revenue declined 2% due to a drop in prices of NAND flash chips. However, many research analysts have recently pointed out that NAND prices are stabilizing after Japanese chipmaker Toshiba scaled back production last year, and this was further supported by SanDisk’s Chief Executive Sanjay Mehrotra’s comment at the recent earnings call that he expects NAND pricing to improve this year. SanDisk Corporation (NASDAQ:SNDK) provided guidance below analyst expectations with revenue of $1.2 billion to $1.3 billion versus analyst expectations of $1.3 billion.
Conclusion
Both Western Digital Corp. (NASDAQ:WDC) and Seagate Technology PLC (NASDAQ:STX) are fairly valued and have good prospects. Increase in demand of mobile phones is still a risk to these companies but rising demand of external hard drives and cloud storage may cushion the fall in revenues. They are good long-term investments, but there is a long-term risk attached as well, and investors will have to decide how long it will take for fortunes to reverse.
Shas Dey has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital..
