Despite the falling demand in the PC market, Seagate (STX) performed extremely well in its past fiscal year 2013. This is evident from the returns it provided. These were equal to 70% of its operating cash flows and 90% of its free cash flows, or approximately $2.1 billion in total. Understandably, this stock has always been a choice for income investors' portfolios.
The company aims at achieving similar investor return targets for this fiscal year too. Although, growing competition from other industry players like Western Digital (WDC) make this expectation questionable. What fundamentals does Seagate possess that will support its goal and help it continue its present bull run?
HDD shipments feeling the heat due to weak PC demand
Seagate's hard disk drive, or HDD, shipments for desktops and laptops saw a negative impact of 4% in the second quarter of this year, on the quarter-over-quarter basis. Despite the fact that PC demand is expected to stabilize in the second half of this year, due to an enterprise refresh and consumer seasonality, we still believe growth in PC demand is quite uncertain on the long-term basis. This is primarily due to the rise in sales of smartphones and tablets. Since 44% of the company's sales come from PC sales, this will have a significant overhang on Seagate's HDD shipments.
This decline in sales of HDD through PCs was offset by the growing shipments of its nearline drives, which led to a sequential growth of 3% in the enterprise segment of the company in the second quarter this year. Nearline storage is an intermediate type of storage device that is a compromise between online storage and offline storage. As per the IDC reports, by 2015 nearly two-thirds of compute devices will be smartphones and tablets, which will drive the growth in demand for cloud storage. Henceforth, this provides us with lot of confidence regarding the future demand for nearline storage.
Going forward, we expect Seagate to continue this similar performance in fiscal year 2014, based on the growing number of applications shifting to the cloud. Most of the content is being created on smartphones and tablets, along with being stored in the cloud environment. Seagate's cloud business will benefit from the shift, as the company expects its cloud storage shipments to rise by 25% from 2011, to 60% by 2020. This means 450 exabytes of storage shifted to cloud and 2001, will grow to 6 zettabytes in a span of nine years.
Acquiring smaller companies - a fixed mantra
In the storage industry, Seagate and Western Digital together have a market share of nearly 86% and combined revenue of about $30 billion, as of the second quarter of this year. History indicates that both companies have been highly competitive. However, Western Digital has maintained the No.1 position in this industry. It has a market share of 45% followed by Seagate's 41% market share in terms of HDD shipments, as of the second quarter of this year. To stay competitive in the market, these companies acquire smaller companies from the storage device industry, which helps enhance each company's product portfolio and expand its presence.
Last month, Western Digital acquired Virident, which is a Peripheral Component Interconnect Express, or PCIe, card maker. It's an interconnection system between a microprocessor and attached devices, and provides expansion slots for high speed operations. Based on IDC's projection for the PCIe market to grow at an annual rate of 31% in the coming three years, Western Digital aims to capitalize on this huge opportunity and expand Virident's supply chain.
Earlier this year, Seagate had struck a deal buying a stake worth $40 million in Virident. Through this deal, Seagate allowed Virident to use its OEM and distribution channels for its FlashMAX cards. This indirectly expanded Seagate's solid state portfolio. Although the company hasn't disclosed any details, it is known that Seagate is receiving a good return on this investment. This had led to speculation of Seagate considering acquiring Virident.
The Western Digital - Virident deal, now questions Seagate's growth strategy going forward. This provides more confidence on the possibility of Seagate acquiring Fusion-io (FIO) in the near term. Fusion-io is a close competitor to Virident. It has been on the acquisition radar for nearly two years. It has a long list of clients like Apple (AAPL) and Facebook (FB), and other Internet giants like Alibaba and Pandora (P).
Presently, the market value of Fusion-io is around $1.3 billion, trading at 2.5 times its revenue, posting over $432 million in the trailing 12-month period. This makes it bigger in terms of acquisition when compared to Virident. Given that Western Digital paid about 6 times the sales of Virident, the Fusion-io acquisition would be a much better deal for Seagate in terms of future market share growth and investment returns.
'Buy' is the word
Since the Western Digital - Virident deal, the speculation surrounding the possible Fusion-io acquisition has led to a rise of over 8% in Seagate's market price since September 9, 2013. This reflects investor confidence toward the company's future prospects. Additionally, Seagate has been able to distribute cash, in the form dividends and share buybacks, over the past several quarters. This is mainly due to its strong cash flows, and given its positive fundamentals, we expect the company to continue this upward streak in its market price in the coming quarters also.
Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Rohit Gupta, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.