On The Value Of Users, Hard Drives And Batteries - Part 3

| About: Western Digital (WDC)
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Barclays is wrong

Western Digital (NYSE:WDC) booked 680 M in net profits in Q3 w/ only 3.5 weeks of HGST revenue and profits included. What will the company's earnings be in FQ4 with 12 weeks of HGST earnings?

Barclays (BARC.L) boosted its target price on shares of Western Digital from $45.00 to $49.00 on April 30th, 2012.

Exactly 4 weeks later:

Barclays downgraded Western Digital Corp. from Overweight to Equalweight and lowered the PT from $49 to $37 with Analyst, Ben A. Reitzes, saying in part:

"Downgrade to EW given several factors that could keep shares range-bound over the near term. This call is not really about the current quarter, but certain developments could impact guidance around September and December."

A look at the specific language is interesting - take for example the following:

"...that could keep shares range-bound over the near term"

mafiosiDoesn't this comment refer to "price" of the shares in future time, an event Mr. Reitzes has precisely zero chance of knowing with any degree of accuracy? Wouldn't it be wiser to speak of the "value" of the company in terms of what can be known in future time with some approximate accuracy? Besides how is the term "range-bound" useful, if he does not tell us what the "range" is? for example, if the range is $35 (est. FQ4 book value) - $80 (low FQ4 13 intrinsic value estimate) per share it seems reasonable (after checking to make sure your health insurance is active), that if you don't have the cash, you might take out loans with your friendly neighborhood Mafiosi in order to buy shares of WDC at a 10:1 leverage ratio. Just to be clear your broker provides the leverage, not the initial loan - We understand the participants in this instance could be easily confused.

Next Up:

"This call is not really about the current quarter, but certain developments could impact guidance around September and December"

Could anything be more vague? The current quarter is the most tangible and immediate information available, yet, Reitzes is discarding those figures wholly in favor of "certain developments" which he does not clarify, and which etymologically must take place in an unknown future. These hypothetical events, in Reitzes own words will not affect the mysterious "range" of prices (not value) which we can only guess at, but only "could impact guidance" - but he does not clarify whose guidance, or how it will be impacted? He only provides a time frame for this exceedingly unfocused forecast, which is some six months into Amvona book value forecast which is based on actual figures.

Finally this:

"Specific factors include (Neutral to Negative) news on PC flow, increased inventories and secular concerns."

This statement of course is anything but "specific," for starters, if the news were to be "neutral" (one option provided), it most certainly would not have the same impact to "the range" as say "negative" news, which is "specifically" different. Further, the term "PC flow" is not described, nor is the relationship between "PC flow" and "storage demand." What we do know is that WDC functions to service "Storage" needs, not "PC Flow," as evidenced in the CEO's own comments above.

Then there is the very unspecific mention of "inventories," but we have no clue whose inventories (e.g. component suppliers etc)? Finally there is "secular concerns," one of our favorite terms because it almost sounds smart. According to Reitzes "secular concerns" constitutes "Certain Developments" approximately two quarters from now, a period of time when all we know is that the "guidance" might be impacted - we can find no way to reconcile the time frame mentioned in the opening remarks namely, "the near term" with "secular" (concerns) an adjective used to describe a long-term time frame, usually at least 10 years.

Incredibly, the man in 44 words has accomplished what few others could, he has said absolutely nothing while still sounding impressive.

The result is that Ben Reitzes' appraisal of the company changed by nearly 3 B when he lowered his price target from $49 per share (slightly above tangible equity projections in one year) to $37 per share (in one year) or approximately 18% below the equity projection, or a P/B ratio in one year of just .82 (or 68% less premium than WDC just paid for the smaller Hitachi (HIT) unit HGST.

How can an opinion change so wildly in only 4 weeks? Do global economics really shift that quickly?

Is it possible that Dell (DELL) sales (one of the events Reitzes appears to be referencing) slipped because it's Dell and has its own specific business model, and not because contraction in storage demand? Future Apple (NASDAQ:AAPL) devices utilizing SSD for instance will still upload to the cloud - doesn't matter how many tablets or ultra books are sold, especially since many ultrabooks will likely still have HDD's - both are designed to have paid subscriptions to iCloud, which might as well be called iWDC.

The Future

It appears clear that WDC intends to be a major player in the ultrabook market, unfortunately they've partnered with a small concern which nobody apparently has heard of, it's a little company called Intel (NASDAQ:INTC) which recently announced collaboration on a new 5 MM drive specifically for ultrabooks - this appears to be what Coyne was referencing in his press release on HGST above.

2.5 driveA 10k rpm, 5 mm hybrid HDD in a 2.5" form factor is right around the corner. Such a device seems very appealing from a technology/cost standpoint in reference to SSDs. Its life span will probably exceed that of SDDs and its price will likely still be ~1/10 that of SSDs when they come to market. Given that Intel is invested in this technology, WDC leadership position, and the fact that SSDs only have 4% market penetration, there seems plenty of "runway" for WDC to continue to transition its business to whatever new technology will meet future storage needs best.

The CEO of Seagate (NASDAQ:STX) when asked about the possibility of SSD taking market share in the aftermath of the Thai floods had this to say:

"Some of it, but not very much. I think to the extent that there is a high value purchaser who can afford to pay $200 for 100 gigabytes, then that market will expand from 1-2 percent to 3-4 percent. Of the 35 to 40 percent shortage that exists, could you see a little of that get absorbed by silicon? The answer is yes. But there's a cap. There's just not enough of a raw supply of silicon to meet all the demand. Our industry will ship 400 exabytes this year. We would have shipped 450, were it not for the floods. Of that, 180 exabytes is notebooks. Reduce that by 30 percent, and you get about 55 or 60 exabytes. If you were to take all of the capacity from Samsung's newest state-of-the-art flash factory, and dedicated it just to notebooks, it would only put out 7 exabytes a year. Plus, there are already other markets demanding flash, like tablets and cellphones and other things. So it's not like you can steal from those other markets. You're not going to take a $32 product and replace it with a $350 product. Can you do it at the edges of the market? Sure. But the threat is capped by the amount of silicon available and the price point for flash storage, which is still an order of magnitude higher."

According to Cisco's IP traffic forecast mobile traffic is forecast to grow 18x from 2011 to 2016 - a positive for vendors with strong mobile networking exposure. Cisco (NASDAQ:CSCO) also sees over half of all 2016 traffic coming from Wi-Fi networks, and expects the number of global Internet users, boosted by smart phone adoption, to reach 3.4B (up from 1.9B in 2010) - that's a CAGR of 29% in the next 4 years to 1.3 zettabytes, or the equivalent of 38M DVDs per hour. By comparison, IP traffic from 1984-2012 was a mere 1.2 zettabytes.

A few highlights

  • It's AAPL (mfg. in China) vs. Intel, Microsoft (NASDAQ:MSFT) and WDC (mfg. in Taiwan)
  • Ultrabooks will be a big bet for the latter three, one that they are probably not willing to lose
  • The latter will focus on IvyBridge married to Win 8, and ultra slim HDD's
  • WDC's jettison of the 3.5" form factor to Toshiba implies future focus will be on 2.5" form factor and 5 mm thickness
  • WDC now has 10K RPM 1TB 2.5" drives which approximate SSD performance at about one tenth the cost
  • WDC is already in SSD business, has been for sometime, and has imminent plans that they are not yet disclosing
  • According to Steve Luczo of STX, there may not be enough SSD material globally to meet demand at any price point
  • Older magnetic media mediums such as Tape still represent a cost effective solution for archival storage, which is an important and large segment of "the cloud," lending further credibility to the thought that HDD media will be around for some time to come
  • WDC's acquisition of HGST indicates a new focus on enterprise storage and more specifically SSD in enterprise applications
  • Tablets and ultrabooks which continue to utilize only SSD will still have limited memory (even as SSD prices fall), b/c mfg. want to sell subscriptions to cloud based storage as it represents a recurring revenue stream.
  • The cloud is largely comprised of mechanical storage and will continue to be for the foreseeable future (see case of FB / Google (NASDAQ:GOOG) above)
  • First impressions when buying an iPad - are the choices really only 8, 16, and 32 GB of onboard memory? It's like some sort of bad joke unless you're an HDD manufacturer that is.
  • WDC FQ4 net earnings are likely to be at least 700 M - of which ~466 M would have already been collected by end of May (2/3 of the way through the quarter). That means another $1.79 per share in book value in FQ4 2012 alone.

Mr. Zuckerberg is right. It is very important to look after the interests of investors. After all investors hand over their wealth in a sacred act of trust. The idea is a simple one and quite old - the manager should use their "talents" to return a larger figure than was originally deposited. Being aggressive is fine, so long as it is done wisely, and truly with the investors best interests in mind and not the managers.

It is important to be open and specific on this point and to avoid any discussion that involves confusing language or motives, or subtle contradictions that might confuse. It would also be nice if the manager can accomplish the task somewhere in the span of a life time - 365 days for example would be good. For this reason, between Friday June 1st and Tuesday June 12th, 2012 we continued to plow huge sums of investors' capital into the shares of WDC (at around $30 per share) as we continued to build what was already a large stake in the company.

Time will tell if it beats an investment in Facebook (NASDAQ:FB).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.