Not Too Late To Get Into Storage Consolidation

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Includes: DVMT, FB, INTC, MU, NTAP, SSNLF, STX, WDC
by: Dana Blankenhorn

Summary

Western Digital's Skyera purchase points the way to continuing consolidation.

The big storage companies are available at multiples in the teens.

Buy Seagate for yield, Western Digital for leadership or Micron for value.

It's not too late for you to get into the consolidation of the storage business, and the price will be as cheap as chips.

The purchase of Skyera by Western Digital (NYSE:WDC) points the way to a storage market dominated by three U.S. players - the other two being Seagate (NASDAQ:STX) and Micron (NASDAQ:MU).

The good news is you can get any of them for a P/E within current market ranges. Micron is currently selling for just 13 times earnings, Seagate for 14 and Western Digital for 16.5.

All these stocks have rolled over in the current market turbulence and are on sale. Despite recent falls of a few dollars per share each, Micron is up 44.5% over the last year, WDC 33% and Seagate 27%. Seagate also offers a premium yield of 3.39%, paying 38% of its most recent quarterly earnings to do so.

While fewer people are buying standard hard drives, like those made by Western Digital and Seagate (because clients like phones and tablets that use chip-based memory), the market for those disks still has room to grow. Home servers, tied to home routers with multiple terabytes of storage, are now making their way into homes under brands like Western Digital's own MyCloud, at half what PCs and tablets cost. (Seagate calls its line GoFlex.) The good news is that, instead of being sold under someone else's name, this gives the hard drive makers a consumer go-to-market opportunity, under their own brand names.

Demand for cloud storage, meanwhile, continues to explode. This is a business both hard drive companies understand, an Original Equipment Manufacturer business in which the drive is hidden inside a larger product. Companies like EMC (EMC), Isilon (ISLN) and NetApp (NASDAQ:NTAP) still have a viable market, unlike the PC makers, because it's still cheaper for companies like Facebook (NASDAQ:FB) to buy mass storage units from these vendors than to build their own from parts.

Micron is on the buy list here because, in general, the world is moving toward chip-based storage, and it has a virtual oligopoly in these chips alongside Korea's Samsung (OTC:SSNLF). The difference is that Micron offers a "pure play" in this area. Companies like Skyera pack Dynamic Random Access Memory, or DRAM chips, at high density to create cloud storage units as big as 136 Terabytes each. Western Digital's HGST unit, which will take control of Skyera, sells these units directly against EMC and NetApp.

Micron sells at a lower multiple than the other two because its performance tends to be volatile. It lost over $1 billion as recently as 2012, and while it brought 18.6% of its revenue to the net income line in fiscal 2014, which ended in August, it was suffering a margin squeeze just a year ago. Less competition should mean less earnings volatility going forward. Throughout the company's life it has been the subject of takeover rumors due to this volatility, but to date it has always been a buyer and, with a market cap now of $36 billion, it could only be swallowed by an ultra-large company like Intel (NASDAQ:INTC).

These stocks are not generally going to be high flyers, so a premium P/E is uncalled for. But with less competition going forward, and the size of their markets increasing, you have a real opportunity for profit in the storage space. You can buy Seagate for yield, Western Digital for leadership or Micron for value.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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