STX: Seagate Technology Is Dead Money

Seagate has lost its mojo, and Western Digital is stealing the spotlight

All successful companies are built like sharks. Part of the reason why the shark is such a successful hunter and a ferocious beast is because it has no choice but to constantly swim to ram enough water through its gills to stay alive. It either swims or dies, period.

Seagate STXThe same aphorism can be applied to successful companies. They are constantly moving and innovating but if they stay still for too long, some upstart somewhere ends up eating their lunch. Seagate Technology (STX) is, unfortunately, beginning to look like a great white that forgot how to swim.

And now the world’s once-largest manufacturer of hard disk drives is being shredded to pieces, forced to cut 2% of its workforce. Let’s look at how STX got itself in this position, and why it’s not going to make a comeback anytime soon.

STX Made Some Bad Acquisitions

About 10 years ago, Seagate was a well-respected HDD manufacturer, the largest on the planet. The company’s market share was 60% bigger than second-placed Western Digital (WDC), its fiercest rival. But then the mobile revolution shook up the data storage industry, leading to an unprecedented spate of consolidations.

From more than seven large HDD players a few years ago, we are now down to just three — Seagate, Western Digital and Toshiba.

STX had the financial wherewithal to acquire almost any company in the HDD universe when merger-mania hit the industry about eight years ago. But the company’s main focus was on buying beleaguered companies on the cheap. So while it could have purchased fourth-largest Hitachi Global Storage Technologies, a highly innovative storage company, it instead opted to gobble up troubled Maxtor, the third-largest manufacturer but already in serious decline, for $1.9 billion.

Meanwhile, Western Digital bid its time before buying out HGST in 2012 for about $4.8 billion. Western Digital’s buy now seems highly strategic in hindsight. The company has managed to leapfrog STX in HDD market share, a critical growth metric that investors use to assess the health of these old-line storage companies. By the end of the first quarter, Western Digital held an industry-leading 43.6% market share, compared to Seagate’s 40%.

But even more critically, Western Digital HGST buy helped it to almost completely close the gap between the average selling price of its HDD products and those by Seagate. Before the HGST merger, STX products easily managed to maintain an ASP about 25% higher than Western Digital, mainly because of Seagate’s lead in enterprise-grade HDDs.

But Seagate’s HDD products can no longer command the huge premium they did a couple of years back. By the end of the first quarter, the huge gap between Seagate’s and Western Digital’s ASP had almost entirely disappeared — $62 vs. $61.

And this is only part of Seagates’ woes.

Seagate Losing the Innovation Game

HGST’s considerable edge in innovation and superior manufacturing technology are now clearly showing. HGST launched the world’s first all-helium drives back in 2012. These are drives filled with helium instead of normal air. Being much lighter than air, helium imposes much less drag on rotating disc platters, thus allowing discs to spin faster and platters to be packed more closely. In short, much more data can be crammed on an average helium drive than on an air drive.

Another strong selling point of helium drives is that they are hermetically sealed, thus allowing them to be cooled with water. This makes the disks ideal for use in large data centers where the cost of cooling servers constitutes a huge part of the cost of running the data center.

STX followed on Western Digital’s helium drives by launching its kinetic drive storage that allows apps to communicate directly with Ethernet, which (according to STX) allows storage infrastructure to be lowered by about 50%.

But Western Digital’s helium drives win hands-down because, while having fast-loading apps sounds great, most organizations just want to transfer massive swathes of data to and from the cloud … not just apps. About 60% of datacenter workloads come from the cloud, but not all of that is necessarily app-related

Meanwhile, Western Digital revealed earlier in the year that it had hit the 1 million helium drives sold milestone, and remains confident that 80% of all its HDD shipments in 2018 will be of the helium variety.

Western Digital Winning the Flash Market

HGST (and thus Western Digital) is ranked the third-largest flash manufacturer after Diablo and SanDisk (SNDK). Seagate has once again been forced to play catch-up here. The company has long remained recalcitrant about the future of solid state drives, or SSDs, but has finally woken up and smelled the coffee.

Seagate has started making a frenzied bid to gain a proper foothold in the flash market, but is going about it the wrong way by cobbling together tiny flash acquisitions.

Seagate acquired LSI Technologies for $450 million last year, and recently announced its intention to purchase Dot Hill (HILL), a hybrid flash manufacture, for a $694 million, or a huge 88% premium to the company price before details of the merger hit news feeds. Hybrid flash storage typically consist of lots of HDD spindle with about 2% to 3% of flash sprinkled in.

Hybrid storage made a lot of sense back in the day when SSDs were prohibitively expensive. But the industry is now moving in the direction of all-flash as the pricing gap between HDDs and SSDs continues to narrow down. Seagate’s latest flash acquisition hardly looks like a wise use of investors’ resources.

The Killing Blow Against STX

But worst of all is the fact that STX seems to have lost its manufacturing edge. A test done by online backup company Black Blaze on hard drives from the existing manufacturers (excluding Toshiba) revealed that HGST drives had the lowest annual failure rate while Seagate’s drives had the highest rate of failure.

While Seagate’s drives might not exactly be rubbish, there are only three other HDD manufacturers on the globe, so it needs to stay on top of things if it wants to avoid bringing up the rear. And that’s the fundamental problem here: Seagate’s recent history has put itself in a position that’s going to be extremely difficult to recover from. Job cuts will only help so much.

Seagate allowed itself to slip, and now it’s facing a rival that seems to be making smarter acquisitions and consistently innovating faster. That’s a one-two punch that may lead to a knockout victory for WDC.

All these problems have been reflecting on STX stock. Western Digital stock has played second fiddle to STX stock in the past, but now the tables have turned. STX stock is badly underperforming Western Digital after tucking on gains of 58% over the past three-year period compared to 95% for Western Digital.

STX stock has lost its mojo. Don’t waste your money betting on a comeback.

As of this writing, Brian Wu did not own any of the aforementioned securities.

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