Seeking Alpha
Profile| Send Message| ()  

Valuations of the two market-leading hard disk drive (HDD) manufacturers Seagate Technology (STX) and Western Digital Corporation (WDC) reflect the widespread belief that the days of HDD as the key solution for storing information are numbered.

Company

Ticker

Market Cap

P/E ttm

Forward P/E

P/B

Levered free cash flow

Seagate

STX

12.64B

4.7

4.4

3.5

1.55B

Western Digital

WDC

10.07B

6.0

4.8

1.4

1.32B

Table 1: Valuations of Seagate and Western Digital (source: Yahoo Finance Aug 1, 2012 approx. 11:50AM EDT)

To understand whether the demise of HDD is correctly predicted, I dug deeper into the following topics most commonly cited to be the reasons for the depressed valuations of these companies:

  • Death of traditional PC
  • Shift to cloud
  • Solid-state drive (SSD) replacing HDD

six hdd form factors

Picture 1: Six hard disk drives with cases opened showing platters and heads; Current form factors 3.5" and 2.5" along with larger and smaller obsolete form factors 8", 5.25", 1.8" and 1". (source: Paul R. Potts / Wikipedia).

Threat #1: Death of Traditional PC

Death of PC has been proclaimed many times, but it's still here. However, computers capable of serving basic user needs come in many sizes nowadays. You can do surprisingly many tasks with smartphones. With tablets, you can do much more. None of the smallest form factor computers use HDD anymore and they are getting increasingly popular. Therefore, it is easy to understand why people think HDD manufacturers will soon face declining demand.

The devices that do not have HDD store data into flash memory. However, due to cost and other constraints, small form factor computers have only a fraction of storage capacity compared to average desktops and laptops. Therefore, large data amounts need to be stored outside of these devices. I believe bulk of this data as well as any data shared in social networking or other online services continue to go to HDDs for one very simple reason: cost.

options for data storage

Picture 2: Options for data storage outside devices with flash memory.

Threat #2: Cloud

Cloud, along with tablets, is frequently cited as threat to HDD manufacturers. Cloud essentially is an arrangement of computing, storage and networking resources. It does not matter whether each computer has a local storage device or many computers share a large array of storage devices, the data goes either to HDD or SSD as in desktop and laptop. Naturally, the exact type of drive in server environment might be different from consumer equipment due to different requirements on performance and reliability in a 24/7 operation.

I believe bulk of all data stored in most systems continue to be stored to HDDs because that continues to be by far the cheapest way to store data in a way that it can be accessed instantly. However, HDD has one significant problem. It can't perform more than 100-200 random input/output operations per second. Therefore, SSDs performing between thousands and hundreds of thousands of random input/output operations per second are needed in most large computer systems - be it a cloud type of arrangement or something else.

A system that offers both high performance and lowest possible cost per bit is constructed using multiple drive types to form tiered storage architecture. The individual tiers are constructed using either SSD or HDD. Most information out there like pictures and other data from individual users is seldom accessed, but need to be online all the time. This type of information is in time moved to tiers with HDDs, while the most frequently accessed information continues to be served from tiers with SSDs.

Threat #3: Solid-state Drive

SSDs can be used as direct replacements for HDDs. They do not have moving parts like HDDs do. Therefore, they are faster in seeking data, silent, immune to vibration and also consume less power. Solid-state disks are superior to hard disks in many respects except when it comes to storage capacity and price. Therefore, when it comes down to just storing a lot of data, HDD continues to be a superior choice.

People tend to think that the next 10 years will be like the last 10 years and that all components and devices just keep shrinking and getting better and faster. This may not be the case for NAND flash memory - the storage component within a SSD. A study published earlier this year tested 45 different NAND flash chips from six vendors. Their conclusion was as follows:

"The technology trends we have described put SSDs in an unusual position for a cutting-edge technology: SSDs will continue to improve by some metrics (notably density and cost per bit), but everything else about them is poised to get worse."

Each memory cell in flash memory has finite number of program-erase cycles. The technologies enabling cell to store several bits have brought down the cost of flash memory, but have dramatically decreased write endurance of the cells. This can be compensated with data management within SSDs, but it does mean that over time the storage capacity keeps shrinking. This is not the only problem facing solid-state drives when they are scaled below current state-of-the-art 25 nanometer manufacturing process. Therefore, the progress in the next 10 years likely is going to slow down from what it has been up until now.

Fabrication Capacity of NAND Flash

NAND flash consumption is mainly driven by smartphones, tablets and ultrabooks. It has been estimated that Apple (AAPL) alone will consume about 25% of the overall NAND supply in 2012. Solid-state drives consumed about 12% of NAND flash production in 2011. That's about 2.5 exabytes of storage capacity (2,500,000 terabytes). Compared to 400 exabytes of hard disk capacity shipped in 2011, NAND flash fabrication capacity need to be increased manifold for SSD to be able to capture significant share from the overall storage pie. New fabrication facilities cost billions and take years to build. Whenever new NAND flash fabrication capacity comes online, it isn't likely that all that capacity would go to solid-state drive segment.

strorage capacity shipped in 2011

Picture 3: SSD+HDD Storage capacity shipped in 2011. Data sources: Seagate and Gartner.

There is one weak point when manufacturing capacities for SSD and HDD are compared in this way. I would imagine that there is a lot of empty space in an average desktop/laptop HDD. Therefore, smaller SSDs could be used to replace HDDs. The same goes for the amounts of HDD capacity needed for cloud storage. Cloud can be scaled easily to meet aggregate demand, whereas each new hard disk in consumer equipment starts as having most of its capacity unused. That's a lot of unused capacity paid in advance.

Future of Hard Disk Drive

According to Seagate and IBM (IBM), areal density improvements are expected to maintain annual growth rate between 25% and 40% over the next few years. This drives both capacity and performance. However, as there seems to be no signs of achieving rotation speeds beyond 15,000 RPM, maximum data transfer rates are likely to exhibit more modest growth.

Form factors continue to evolve especially in terms of drive profile in order to fit hard disk drive into slim ultrabooks. Another very interesting development is combining flash memory for high performance and hard disk drive for cheap capacity. Seagate has already launched hybrid drives (Momentus XT) that combine flash and hard disk drive within a single device. Another way to combine best of both worlds is to have separate SSD and HDD within the computer.

In the PC market, IHS iSuppli is forecasting that hard disk drive volumes will continue to grow between 2012 and 2015. Volumes of flash-based SSDs will grow dramatically, but even in 2015 they are expected to take only a small portion of the whole cake.

Conclusion

Both hard disk drive and NAND flash are old inventions as technology, but have evolved far and continue to be improved still. It's not relevant to ask which one will take it all. The amount of data increases in a pace that leaves plenty of room for all storage solutions, including various types of HDDs with or without flash.

Therefore, my view is that hard disk drive manufacturers are priced conservatively compared to their future prospects. Whatever the future storage solutions look like, these companies are in good position to be take market share also from the invention that is going to replace hard disk drive. NAND flash based solid-state drive is unlikely that invention.

Seagate and Western Digital have close to duopoly in HDDs. If the storage market continues to expand as predicted and these companies can maintain decent margins, they should be able to make a killing with the technologies, manufacturing facilities and supply chains they master.

Source: Hard Disk Drive Manufacturers Poised To Make A Killing