Seagate Technology: Investors Are Missing The Point

Aug. 1.12 | About: Seagate Technology (STX)

Seagate Technology PLC (NASDAQ:STX) released its quarterly earnings on July 30 and was immediately met with a knee-jerk reaction by investors as the company reported net earnings 5% lower than analysts were expecting. The company stated it had diluted earnings per share of $2.37 compared to the $2.51 analysts were expecting. In the immediate aftermath, shares traded down 9% in after-hours trading in a clear reflection of the volatility suffered by the company.

Yet by the close of Tuesday, July 31, the company was only down 1.35% as the stock rallied back up to $30.02. Over the course of the day, the stock rallied from its open of $27.91 and even went into positive territory for a short time period. Much of the enthusiasm could be found over comments made in the conference call following the earnings release. The transcript of the earnings call can be found here.

The most encouraging news could be found in the company's guidance on its share buyback and dividend policy. Seagate's CEO Steve Luczo stated the following:

We are on plan to reduce our share count to 350 million ordinary shares outstanding by calendar year-end 2012. Assuming market and macroeconomic conditions and the company's performance and valuation metrics are similar to what they are today, we plan to reduce our share count to 250 million ordinary shares by calendar year-end 2014. Given the assumptions stated above, we expect that we will continue to increase our dividend payments in a meaningful manner while continuing our redemption plan over the course of the next several years.

The current number of shares outstanding stands at 411 million as of June 2012 according to the company's recently released earnings. With expectations to reduce the share count to 350 million over the next 5 months, this immediate buyback would suggest that the company is willing to spend $1.83 billion at current market prices! Were the market capitalization of the company to stay at roughly $12.3 billion (as of July 31, 2012), the reduced share count would present a new share price of approximately $35 by the year's end. Factor in the increased dividend guidance, and it appears that Seagate may be in for a near-term bump up in value.

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One interesting note concerning the earnings call is the lack of the company's mention of any possible acquisitions on the table. Most recently, Seagate had been rumored to be interested in buying out OCZ Technology Group (NASDAQ:OCZ). The rumor had also suggested that Micron Technology (NASDAQ:MU) was another interested bidder that could be competing for the acquisition. Yet despite the plausible story backing the industry rumor, the earnings call is likely to have put to rest any further speculation concerning an OCZ buyout. With the hefty amounts of cash needed to buy back the company's shares and increase the dividend, it would seem unlikely that Seagate would be interested in spending heavily on another acquisition that could run up to several hundred million dollars.

Apart from the slight earnings miss that was largely due to a now-resolved supplier issue, Seagate's earnings call was a very encouraging overview of the company and its intentions. The stated ambition to significantly return value to shareholders on both the fronts of an increased dividend and reduced share count should not be taken lightly by current investors. As the company trades with a current enterprise multiple of 4.49. However, it appears as if investors continue to discount the ongoing earning potential of the company.

Seagate has very little room left for acquisitions in the hard drive market space as the company forms a practical oligopoly with its largest peers found in Western Digital Corp (WDC) and Toshiba Corp (TOSBF.pk). With limited competition allowing for increased pricing power and advances being made on the technological front through hybrid drives and solid state drives, Seagate is now ready to focus on returning value to investors. Cash that is pouring into the company is already being redirected towards share buybacks and increased dividends. It remains a wonder as to why investors fail to see the value here.

Disclosure: I am long STX, MU.