Western Digital Seems Extremely Cheap

[MrB]

just a quick comment (too lazy to write a long post), but some things to think about

 

- ItsAValueTrap - everything you wrote is known, nothing new, they are comment thoughts and thinking that is almost part of the investment consciousness. Not saying they are not right. But its things like this that make me think, is the common thoughts incorrect if so then we got a good opportunity here.

 

- think of railroads, railroad for the longest time was a bad business, dieing, no one want it, it was left for dead, until the fundamental nature of the business change, people who notice it early made a killing, WEB notice it, a little later than some. not saying the HD/storage space is exactly the same senario, but it the first analogy i can come up with.

 

- now is WDC/STX a harddrive company or storage company? now if they are harddrive company i would walk away immediately.

 

- fundamentally storage is here to stay, someone/some company will provide storage, the storage might be in the form of HD, solid state, or whatever.... the key is be dominate as THE STORAGE company.

 

- now, is WDC/STX a storage or HD company? If so why, if not why not.

 

hy

 

Great points. Something else. Take a look at the attached 2011 industry prices bearing in mind that drives sold for use in the cloud will fall in the BC and EMC segments. So you can lose a few Desktop HDD sales as long as you sell 1 BC or EMC drive. BC/EMC (3.5" drives) carry lower margins though, so not sure what the exact ratio is.

[hyten1]

MrB good powerpoint slide

 

if you look at slide 40, "What about WDC?" all those point no longer applied? (well except for the flood which did affect WDC, but base on their recent quarter release, it didn't affect wdc in any real negative way)

 

hy

 

 

- fundamentally storage is here to stay, someone/some company will provide storage, the storage might be in the form of HD, solid state, or whatever.... the key is be dominate as THE STORAGE company.

There are different segments of the storage industry.

 

Companies like EMC and Netapp that do enterprise storage are increasingly becoming software companies.  (With some services and integration... because their products are complicated.)  I think that this segment of storage will be an area of a lot of value creation.  Dell paid a ridiculous P/E multiple for Compellent. 

 

There are companies that make flash hard drive controllers (e.g. Sandforce).  These chips will become increasingly complicated as time goes on (in the future, they will have to do a lot more error correction).  There may be some unusual value creation here... though I don't know who the winner will be.

 

There are companies that slap parts together, e.g. OCZ.  I don't think that this is a great industry.

 

There are companies that make the parts that go into a hard drive... e.g. Hutchison Technology.  Not a great industry.

 

Another way to look at it is to look at the industry structure. The suppliers to WDC/STX's numbers look horrible, which makes sense if you are supplying to a consolidating industry. The attached (pages 7-10) gives a good breakdown of the industry.

[MrB]

MrB good powerpoint slide

 

if you look at slide 40, "What about WDC?" all those point no longer applied? (well except for the flood which did affect WDC, but base on their recent quarter release, it didn't affect wdc in any real negative way)

 

hy

Points 1 & 2 is not valid anymore. See page 12 of the attached in particular. I find it rare for managements to think about price when buying back stock and these guys clearly do. Better yet; you have a competitor that think just as hard about value than you do. They already bought back just over $600m and will probably buy back about $1Bn over the next 12 months with a $250m dividend.

 

I don't understand the industry well enough to make an intelligent comment on the last point.

Capital_Allocation.pdf

[hyten1]

MrB

 

yes last point i guess still kind of applies but WDC has strengthen its position in that area with the recent hitachi acquistion

 

"The WD-HGST deal has an SSD angle as well.  Both companies participate in the SSD market through different approaches, although neither has a leading market position at this time.

 

In 2009, WD acquired SSD maker SiliconSystems as a means of entering the SSD market.  Although SiliconSystems had its sights set on the enterprise SSD market, WD’s current offerings are more oriented towards embedded SSDs for the military and industry, with few offerings of any substance in the enterprise space.

 

Late in 2008, Hitachi signed a deal with Intel to produce SSDs that would combine the highly-reputed Intel SSD architecture with Hitachi’s enterprise HDD interfaces.  Hitachi would introduce SAS and Fibre Channel SSDs, with Intel continuing to serve the SATA market.  Last November, Hitachi introduced the first of these products (see “Hitachi GST entersSSD market”).

 

Assuming that the Intel-HGST agreement successfully transfers to WD, WD’s enterprise storage group will finally introduce fast SSDs into the enterprise market."

 

 

http://www.infostor.com/disk-arrays/disk-drives/analysis-western-digital-hitachi-gst-.html

 

hy

[MrB]

MrB

 

yes last point i guess still kind of applies but WDC has strengthen its position in that area with the recent hitachi acquistion

 

"The WD-HGST deal has an SSD angle as well.  Both companies participate in the SSD market through different approaches, although neither has a leading market position at this time.

 

In 2009, WD acquired SSD maker SiliconSystems as a means of entering the SSD market.  Although SiliconSystems had its sights set on the enterprise SSD market, WD’s current offerings are more oriented towards embedded SSDs for the military and industry, with few offerings of any substance in the enterprise space.

 

Late in 2008, Hitachi signed a deal with Intel to produce SSDs that would combine the highly-reputed Intel SSD architecture with Hitachi’s enterprise HDD interfaces.  Hitachi would introduce SAS and Fibre Channel SSDs, with Intel continuing to serve the SATA market.  Last November, Hitachi introduced the first of these products (see “Hitachi GST entersSSD market”).

 

Assuming that the Intel-HGST agreement successfully transfers to WD, WD’s enterprise storage group will finally introduce fast SSDs into the enterprise market."

 

 

http://www.infostor.com/disk-arrays/disk-drives/analysis-western-digital-hitachi-gst-.html

 

hy

 

Correct, but the date and page 13 of said presentation means STX management made that point after WDC/Hitachi deal

[hyten1]

MrB i hear ya, byt no means is WDC on par with stx on the enterprise/ssd, probably not (honestly i am not sure)

 

i just know wdc has been pretty good at what they do, in terms of operations, cost, etc. (wdc has been talking about enterprise/ssd for a while, its an area they are weaker at, its not something they just realize notice recently)

 

hitachi has definitely strength wdc in varies area that they were weak in

 

one way to invest in this space is buy both stx and wdc :)

 

 

[MrB]

MrB i hear ya, byt no means is WDC on par with stx on the enterprise/ssd, probably not (honestly i am not sure)

 

i just know wdc has been pretty good at what they do, in terms of operations, cost, etc. (wdc has been talking about enterprise/ssd for a while, its an area they are weaker at, its not something they just realize notice recently)

 

hitachi has definitely strength wdc in varies area that they were weak in

 

one way to invest in this space is buy both stx and wdc :)

Yes that is a consideration, but what makes me lean towards WDC is what you touched on. I think WDC is much better managed and STX seems to be managed pretty darn well.

Average gross margins over the last decade is 2 percentage points ahead of STX as is operating margins. Lowest cost producer....Capital turns for WDC is also markedly better and more aggressive buyback, which is preferable at these prices. Even just buying STX is also a strategy I find hard to fault.

 

[hyten1]

MrB i agree i mean one thing I found interesting wdc has been more consumer oriented and stx enterprise yet wdc has better margin :)

 

 

[ItsAValueTrap]

Technical Note: SSD or solid state drive is essentially flash in a tray. Think of a SD card, made bigger and put in a tray to use as a hard drive in your laptop. Same technology, different use.

I think that it's important to note that solid state drives differ in performance mainly due to the flash controller and the type of flash used.

 

The companies making the flash controllers may make some very good profits... an example would be LSI buying Sandforce.

 

These technologies compliment each other.

In some cases they compliment each other, in some cases they don't.

 

Part of the analysis will rest on your forecast between what the mix of flash and hard drives will be in the future.  Look at it from the point of view of the consumer buying a laptop.

Do they go with flash:  high performance, computer boots in several seconds, somewhat lighter, longer battery life?

Or do they go with hard drive:  more storage, lower price, etc.

 

It also depends on whether some new feature/application will cause consumers to need a lot of storage space.  Currently, really the only thing that consumers need a lot of storage space for is video.  Maybe really fast Internet will cause people to do a lot of streaming and not need a lot of local storage.  Or maybe not.  If you look at audio, we are at the point where many people use Spotify/Grooveshark and don't even need to store music locally anymore.

 

10 years from now, things might look like this:

If storage capacity doubles every 2 years, then storage capacity in the future will be 32X what it is today.  (*It may be less because flash has problems scaling down to smaller transistors.)

A 40GB flash drive today will be 1280TB in the future.  A Blu-ray disc is 25GB so you can store about 51 Blu-rays (*this math is a little wrong since drives hold less after they are formatted).  This could be enough for 90% of people out there.  Then there are people who do need more storage... they will simply buy hard drives on top of their flash drive.  Maybe people will move towards 4K resolution which will take up 4 times the amount of space, assuming no advances in compression technology.  If video moves towards 60fps instead of 24/30fps and 3-D instead of 2-D, then storage requirements will be higher.  But I think that almost everybody will be booting off a flash, or a flash/hard drive hybrid (the latter scenario is beneficial for Seagate/WDC).

 

On the server side of things, the picture probably won't look as bad.

[Kiltacular]

Mr. B,

 

STX has been discussed extensively on Motley Fool -- particularly by poster: "mungofitch"  (smart person, rational).

 

Check out the "Falling Knives" board.

 

Here is the most recent thread: http://boards.fool.com/fka-stx-again-30351385.aspx?sort=whole

 

Towards the end, it is mentioned that maybe WDC is the better buy.

 

Here's an even older thread: http://boards.fool.com/fka-stx-30054822.aspx?sort=whole

 

You might want to start with the older thread.  This is a very interesting situation.  Your general conclusions fit with mungofitch's.

 

kiltacular

[ShahKhezri]

From Barron's:

 

WESTERN DIGITAL and rival disk-drive maker Seagate have languished amid worries about the future of the PC market. The two major players trade at single-digit price/earnings ratios. Our preference now is for Western Digital, which has badly trailed Seagate this year. At $37, the shares trade for less than five times projected profits of $7.65 a share.

 

The disk-drive market remains substantial, with annual sales of more than 500 million storage devices. While PC sales aren't growing, demand for storage is, and other forms of memory are too costly for storing massive amounts of data. And since Seagate and Western Digital control more than 80% of the market, pricing pressures are unlikely. Western Digital has a strong balance sheet, with $1.4 billion, or $5 per share, in net cash. Given that and its earnings power, a leveraged buyout of the company is possible.

 

The company has pledged to earmark half of its free cash flow for stock buybacks and dividends, and there's room to boost the payout, which at 2.7% is just half of Seagate's. Needham analyst Richard Kugele has a Strong Buy rating on Western Digital and a $46 price target.

 

No position, but looks interesting. 

[MrB]

Technical Note: SSD or solid state drive is essentially flash in a tray. Think of a SD card, made bigger and put in a tray to use as a hard drive in your laptop. Same technology, different use.

I think that it's important to note that solid state drives differ in performance mainly due to the flash controller and the type of flash used.

 

The companies making the flash controllers may make some very good profits... an example would be LSI buying Sandforce.

 

These technologies compliment each other.

In some cases they compliment each other, in some cases they don't.

 

Part of the analysis will rest on your forecast between what the mix of flash and hard drives will be in the future.  Look at it from the point of view of the consumer buying a laptop.

Do they go with flash:  high performance, computer boots in several seconds, somewhat lighter, longer battery life?

Or do they go with hard drive:  more storage, lower price, etc.

 

It also depends on whether some new feature/application will cause consumers to need a lot of storage space.  Currently, really the only thing that consumers need a lot of storage space for is video.  Maybe really fast Internet will cause people to do a lot of streaming and not need a lot of local storage.  Or maybe not.  If you look at audio, we are at the point where many people use Spotify/Grooveshark and don't even need to store music locally anymore.

 

10 years from now, things might look like this:

If storage capacity doubles every 2 years, then storage capacity in the future will be 32X what it is today.  (*It may be less because flash has problems scaling down to smaller transistors.)

A 40GB flash drive today will be 1280TB in the future.  A Blu-ray disc is 25GB so you can store about 51 Blu-rays (*this math is a little wrong since drives hold less after they are formatted).  This could be enough for 90% of people out there.  Then there are people who do need more storage... they will simply buy hard drives on top of their flash drive.  Maybe people will move towards 4K resolution which will take up 4 times the amount of space, assuming no advances in compression technology.  If video moves towards 60fps instead of 24/30fps and 3-D instead of 2-D, then storage requirements will be higher.  But I think that almost everybody will be booting off a flash, or a flash/hard drive hybrid (the latter scenario is beneficial for Seagate/WDC).

 

On the server side of things, the picture probably won't look as bad.

 

Two things play in my mind when I hear the concerns about HDD in notebooks "going away" ; a) storage moves somewhere else rather than being eliminated and b) where it moves is a place where HDD costs 3-4 times as much.

So there is a trade off between selling less HDDs, but much higher priced ones albeit at lower margins.

Is that made up by the low valuation/duopoly?

Not exactly sure what the answer is, but that pretty much drives at the heart of the investment case for me.

 

[MrB]

Mr. B,

 

STX has been discussed extensively on Motley Fool -- particularly by poster: "mungofitch"  (smart person, rational).

 

Check out the "Falling Knives" board.

 

Here is the most recent thread: http://boards.fool.com/fka-stx-again-30351385.aspx?sort=whole

 

Towards the end, it is mentioned that maybe WDC is the better buy.

 

Here's an even older thread: http://boards.fool.com/fka-stx-30054822.aspx?sort=whole

 

You might want to start with the older thread.  This is a very interesting situation.  Your general conclusions fit with mungofitch's.

 

kiltacular

 

Thank you will, take a look

[MrB]

11.29 S-8 filing

 

New shares to be registered under 2004 Performance Incentive Plan 13.2m

New shares to be registered under 2005 Employee Stock Purchase Plan 8.2m

 

Current outstanding under both plans 22m (17m for rank and file employees)

 

Current shares outstanding 243m

 

So about 1.6%/annum or $150m-$300m that you can add to payroll expense; hopefully it buys more in motivation.

 

 

[menlo]

Quite a bit on WDC from these guys....  http://www.amvona.com/featured/finding-alpha/item/13599-is-western-digital-an-ideal-acquisition-target

[MrB]

Western Digital - Presentation by Chris Mellor of The Register

[writser]

The problem with Western Digital for me is: basically all companies in the "dying pc sector" sector look like decent investments to me. Other examples include Seagate, Marvell, Intel, Qlogic, Intel, Microsoft, Cisco and Dell. These show up in portfolios from managers I respect (Einhorn comes to mind) and in several screeners, for example the Magic Formula. But I already have positions in MSFT, CSCO and INTC and I don't want too much exposure to the sector. I have a hard time figuring out the best stocks. I like MSFT and INTC because of their moats but from a valuation perspective other options appear to be cheaper. Maybe I should just buy the whole basket equally weighted, saves me some thinking. Somebody should launch a new fund for that, I believe the "OKPC" ticker is still available.

[Palantir]

Maybe I should just buy the whole basket equally weighted, saves me some thinking. Somebody should launch a new fund for that, I believe the "OKPC" ticker is still available.

http://us.ishares.com/product_info/fund/overview/IGM.htm

 

http://us.ishares.com/product_info/fund/overview/IGV.htm

 

http://us.ishares.com/product_info/fund/overview/IYW.htm

[writser]

Thanks; problem with these is that they also contain some holdings that I don't like. For example I am short Sales force and that's a major holding in one of them. The other one is 20% Apple. IGM is the most interesting one but the overlap with the stocks I mentioned is < 20%. I think I am better off buying individual shares.

[ItsAValueTrap]

Two things play in my mind when I hear the concerns about HDD in notebooks "going away" ; a) storage moves somewhere else rather than being eliminated and b) where it moves is a place where HDD costs 3-4 times as much.

So there is a trade off between selling less HDDs, but much higher priced ones albeit at lower margins.

Is that made up by the low valuation/duopoly?

Not exactly sure what the answer is, but that pretty much drives at the heart of the investment case for me.

 

If you look at mp3 players... the history has been that hard drives got killed by flash (remember non-flash iPods?).  We just... stop increasing storage.

 

2- Whether this will play out in the laptop and desktop space remains to be seen.  Right now, the only thing that consumers need a lot of storage for is video.  In my opinion, video will play out a lot like audio.  In the audio world, mp3s at a bitrate of 128/192kbps is good enough for almost everybody.  We even developed better audio compression (e.g. AAC) but mp3s will remain the most popular due to its license-free nature and its popularity.  For video, I think most people will be happy with less than Blu-Ray quality (or Blu-Ray quality).  We already know the answer to this because movie theatres released some movies in 4k and nobody cared (Sony has a list of 4k releases on its website).  2K/1080p is good enough for most people.  Then it comes down to how much compression people are willing to accept... Youtube is not quite good enough, Blu-ray may or may not be overkill.

 

Is that made up by the low valuation/duopoly?

The valuation comes down to predicting future cash flows.  I'm not smart enough to predict future cash flows with high precision or accurate.

 

But I don't think that the HDD makers will be able to consistently maintain high returns on capital.  I might be wrong here, but historically it has never been this high and the secular growth in computing was much higher in the past than it is today.

[MrB]

Someone put a firecracker under the industry's *** today?

 

 

http://biz.yahoo.com/ic/ll/813pip.html

 

Leaders in Price Performance (Intraday) 

Hutchinson Technology Incorpora [htch]  +8.64% 

SANDISK [sndk.mx]  +6.21% 

Xyratex Ltd. [xrtx]  +5.78% 

Quantum Corporation Common Stoc [qtm]  +4.76% 

STEC, Inc. [stec]  +4.56% 

Emulex Corporation Common Stock [elx]  +4.43% 

SINGULUS TECHNOLOGI [sng.de]  +3.35% 

Western Digital Corporation [wdc]  +2.26% 

OCZ Technology Group Inc [ocz]  +2.16% 

Seagate Technology. [stx]  +2.01%

 

[MrB]

The problem with Western Digital for me is: basically all companies in the "dying pc sector" sector look like decent investments to me. Other examples include Seagate, Marvell, Intel, Qlogic, Intel, Microsoft, Cisco and Dell. These show up in portfolios from managers I respect (Einhorn comes to mind) and in several screeners, for example the Magic Formula. But I already have positions in MSFT, CSCO and INTC and I don't want too much exposure to the sector. I have a hard time figuring out the best stocks. I like MSFT and INTC because of their moats but from a valuation perspective other options appear to be cheaper. Maybe I should just buy the whole basket equally weighted, saves me some thinking. Somebody should launch a new fund for that, I believe the "OKPC" ticker is still available.

 

Might also be the most intelligent way to approach an investment in this case.

[MrB]

Mr. B,

 

STX has been discussed extensively on Motley Fool -- particularly by poster: "mungofitch"  (smart person, rational).

 

Check out the "Falling Knives" board.

 

Here is the most recent thread: http://boards.fool.com/fka-stx-again-30351385.aspx?sort=whole

 

Towards the end, it is mentioned that maybe WDC is the better buy.

 

Here's an even older thread: http://boards.fool.com/fka-stx-30054822.aspx?sort=whole

 

You might want to start with the older thread.  This is a very interesting situation.  Your general conclusions fit with mungofitch's.

 

kiltacular

 

a. From the links you mentioned.

 

"The bearish cases which seem to me to be driving down the price are, in no particular order:

1 - hard drives have moving parts and consume too much power, so they are going into end-of-life soon (discussed above)

2 - tablets and SSD-only systems are replacing PCs with hard drives

3 - the business cycle is slowing so shipments are easing and earnings are moderating

4 - hardware components are all low-margin commodity businesses and

competition will come in to eat their lunch because the tech isn't that hard.

 

Of those three, I believe #2 and #3 are red herrings.

The replacement is merely a displacement which isn't reducing the

growth rate of aggregate storage demand, and the cycle is just a cycle.

It doesn't make sense to sell your farm just because winter is coming.

 

#4 is most prevalent among people who haven't looked at the numbers

or the consolidation, as it certainly isn't true based on the empirical

evidence. But it could have some merit some day.

Like many businesses with mere "scare them away" moats, the continuation

of the high returns relies on the rationality of potential entrants to

the market being rational enough not to enter a market which will

cause all participants to get low returns on capital.

The numbers and the shakeout seem to give some comfort that this

scare-away approach is working and/or the tech is sufficiently hard,

but it's not a bullet proof moat situation. Somebody with a few

billion dollars to spare could enter the market as a new competitor.

 

The good news is that the two issues worth considering, #1 and #4,

are the sorts of things that you'll see coming, they won't be overnight.

That, plus the immense margin of safety in the current price, gives

me the comfort to make this a large allocation.

For the put writer, a flat share price is currently a 30%/year return proposition."

 

b. Earlier in the post he also mentions the internal combustion engine and it's basic technology which have stayed the same throughout the years. Are there similarities and if so how would one go about thinking about it?

 

c. It is a lovely irony that one of the perceived threats, the move to mobile computing and lighter, more energy efficient SSF memory, may actually have the effect of driving more memory to the cloud, where the HD technology is not impeded by weight, and where cost per TB is the predominant factor, that factor being one where the traditional technology still has a huge lead.

 

Interesting angle.

 

 

[Palantir]

Damn you're making a persuasive case for this stock.......basically an old-style rollup in a consolidating/declining industry.

[MrB]

Damn you're making a persuasive case for this stock.......basically an old-style rollup in a consolidating/declining industry.

 

I'm actually not..well I'm trying not too. I am just highlighting the facts, because the more I look at those the more my own reservations seem to be irrelevant. It just seems terribly misunderstood.

 

It does deserve some respect you know ;-)

 

"Like flying a Boeing 747 six inches above the ground"

http://www.atarimagazines.com/v5n6/InsideHardDisk.html