Can Hybrids Extend Life Of Seagate And Western Digital?

| About: Seagate Technology (STX)
This article is now exclusive for PRO subscribers.

The handwriting is on the wall for hard disks, the spinning aluminum disks that have been the standard for mass storage since before I started covering technology.

The increased capacity, falling price, and greater durability of chip-based memory has been steadily making inroads into the hard drive market. Devices like mobile phones and tablets are known for having no moving parts at all - no hard drive sales there.

With chip drives, called Solid State Drives or SSDs, now poised to move into the data center, because they deliver data much faster than a hard drive can, and with Apple (NASDAQ:AAPL) having moved to a "hybrid" drive - combining chips and disk - for its Macintosh line, Seagate (NASDAQ:STX) and Western Digital (NYSE:WDC) have made the smart move into making such hybrids standard.

While Western Digital has just begun shipping hybrids, in 500 MB and 1 terabyte sizes - to its OEM customers, Seagate says it is committing fully to the new technology, dropping its most popular disk-only drives from the consumer line and committing fully to what it now calls Solid State Hybrid Drives or SSHDs.

The question for investors is, how far can this "can't beat 'em, better join 'em" strategy take these companies?

Fact is both are already near their peaks, in terms of price. STX is currently trading at $32.40, 17% higher than its price of a year ago. WDC, at $48 and is up 25% year-over-year.

To many, it makes no long-term sense. If chip-based memory is the coming thing, why are the hard drive makers drawing a big bid? It could be high short interest - Western Digital is one of the most-shorted stocks on the street. It could also be the continuing take-over rumors around Seagate- none of which have come true.

Both companies are heavily favored by institutions. Both companies draw three, four and five star ratings from major ratings groups. Samsung holds a big stake in Seagate, about 10%, and Hitachi holds a similar-sized stake in Western Digital.

Still, these are products that are coming to the end of their useful life, as even their makers are admitting with this latest tweak. While Western Digital is now the 19th largest maker of SSDs, the successor technology, and Seagate is 22nd. Their best routes to growth in this sector may lie in buying one of the existing SSD players, like troubled OCZ (NASDAQ:OCZ). But even there it's hard to see a long-term future - the big memory chip players are starting to make their own drives, and would surely squeeze out such a play over time.

So, with SSDs taking over, with even these two hard drive leaders admitting it with the move to hybrids, how long can they maintain these high valuations? Only as long as they can keep churning out profits. Seagate sports a 3.7% yield and a PE lower than that of Ford Motor (NYSE:F) while WDC has a lower yield but higher earnings multiple.

The bottom line is that these are what I call harvesting stocks. They are harvesting profits in their technology space as that space slowly withers away. The move to hybrids is proof of how their time is passing. If you want to play here, go for the yield, but be prepared to jump at short notice.

These companies are paying you to own them. When they can no longer pay, the bottom will drop out. And their latest moves show that time is coming. It's too early to recommend a short, but that time is coming.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.