As the economy improves, technology will be a prime beneficiary. Ever-increasing data supply will drive demand for computer storage devices. As an IR consultant, I expect IceWEB (OTCPK:IWEB) and Entorian Technologies (OTC:ENTN) to significantly appreciate due to these strong secular trends. The two not-so-well-followed companies are significantly undervalued and have the potential to outperform if only press coverage improves.
In the meanwhile, firms like Seagate Technology (NASDAQ:STX), EMC Corporation (EMC) and Western Digital (NYSE:WDC) receive nearly all of the attention. In this article, I will run you through a DCF analysis on Seagate and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to EMC and Western.
First, let's begin with an assumption about revenues. Seagate finished FY2011 with $11B in revenue, which represented a 3.72% decline off of the preceding year. I model a 22% per annum growth rate over the next six years, roughly in-line with consensus.
Moving on to the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I expect cost of goods sold to eat 77% of revenue versus 4% for SG&A, 8% for R&D, and 7% for capex. Taxes are estimated to trend from 15% in 2012 to 20% in 2017.
We then need to subtract out net increases in working capital. I model accounts receivable as 15% of revenue, inventories as 9% of COGS, accounts payable as 17% of OPEX, and accrued expenses as 180% of SG&A.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 12% yields a fair value figure of $33.13, implying 25.3% upside.
All of this falls under the context of a devastating supply chain disruption, as noted by management:
"The disaster in Thailand affected a vast number of individuals and thousands of businesses. Although the industry is continuing to increase output, it's important to note that while many observers tend to believe that mid to late October was the low point of industry production, we believe the low point was closer to mid-December.
Seagate's geographically diversified factory footprint and broad supply chain provided inherent advantages that mitigated the impact of the floods to Seagate's operations, although many of our external component suppliers are still working to recover their businesses and return to full capacity".
From a multiples perspective, Seagate is highly attractive. It trades at 12.7x past earnings, but only 3x forward earnings. Meanwhile, EMC trades at a respective 26.4x and 14.7x past and forward earnings, while Western trades at a respective 13.1x and 4.4x past and forward earnings. Where Seagate's multiples go from here is largely a matter of speculation, as it is more an issue of macro trends. But with an exit multiple of only 3 required for appreciation, Seagate is in my view at a bottom.
I hold the same view for Western. Consensus estimates predict a wild ride that will help drive high risk-adjusted returns. Management is also equipped with deep-industry knowledge. The $3.9B cash plus equity buyout of Hitachi Global Storages will also unlock revenue and cost synergies, improve scale, and hedge against competitive, as well as macro pressures. The company is already the global leader in external storage solutions; its My Book Thunderbolt Duo dual-drive, the first external hard drive on Thunderbolt Technology, will help extend the lead. With only a multiple of 4.4x needed for value creation, the downside for Western is also minimal, while the upside is explosive.
EMC, on the other hand, has more than 25% of the networked storage market in its bag. To combat competitive pressures, the company is making strong investments in R&D and shifting towards higher margin markets. EMC also has a solid balance sheet that can finance accretive takeover activity. The Isilon acquisition was, for example, a step in the right direction. In the meanwhile, however, headwinds from cloud computing will limit value creation. And, at higher multiples than peers, EMC appreciation will likely underperform that of Western and Seagate in the event of a full recovery.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.