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Is Seagate and Western Digital rally for real or the beginning of the end?

|Includes: INTC, STEC, Inc. (STEC), STX, WDC, WDC

Seagate (NASDAQ:STX) and Western Digital (NYSE:WDC) both had impressive runs this year, up 300% and 280% YTD respectively.  Given that many analysts are predicting a rebound in technology spending next year, this might look like a good time to consider buying STX and WDC.  After all, even after the massive rally, both stocks are still reasonably valued and both are leaders in the desktop HD market.  Looking back at the history of the HD market though, the future of these two companies are far from certain.

The HD industry is littered with examples of disruptive markets and with that, bringing down the incumbent leader.  In the  early 1970s, the dominant HD is the 14-inch HD used on the mainframe computers.  By the end of the 1970s, new entrant firms such as Shugart Associates, Micropolis, Priam, and Quantum entered the market with a new 8-inch HD primarily used by minicomputers.  Even though initially the cost per megabyte of capacity of these 8-inch drives were much higher than the 14-inch HD,  customers were willing to pay for it because the 14-inch drives were too bulky for minicomputers.  This disruption happened again in the 1980s with the introduction of 5.25-inch HD serving the desktop market and in the late 1980s with 3.5-inch HD serving the portable market.  In each case, new entrant firms came in to serve the new market at the expense of incumbent firms.

Today, with the growth of netbooks, UMPCs, smartphones, traditional HDs are no longer the best storage solution for these markets.  SSDs (Solid State Drive) or flash memories are better solutions because of their size, speed, and energy efficiency.  Though they are currently much more expensive on a per megabyte basis, the price has come down significantly and will continue to drop.  New entrants into the HD market such as Sandisk, Intel, and STEC have came out with storage solutions based on flash memory that are orders of magnitude faster than traditional HDs.  Seagate and Western Digital, on the other hand, are late to the game.  Seagate finally announced a new SSD drive for the enterprise market a few weeks ago while Western Digital acquired SiliconSystems in March 2009 to enter the SSD market.  It appears history is about to repeat itself again.  If it does, there probably won't be enough room in the desktop HD market for two players to thrive.

Disclosure: long STEC, long SNDK