Storage Technology Collection

(This article originally appeared in the The Motley Fool's Evening News on Wednesday, February 19, 1997)

FOOL ON THE HILL
An Investment Opinion by TMF Templr

Western Digital and the NC

Talk of a "network computer" by corporate frontmen like Larry Ellison of ORACLE CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %> and Scott McNealy of SUN MICROSYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SUNW)") else Response.Write("(Nasdaq: SUNW)") end if %> is designed to put fear into the heart of Bill Gates, the proprietor of a small software concern in Redmond, Washington. The network computer -- monitors and keyboards with only a minimum of semiconductors and wires tied into a network -- is a concept designed to reduce the cost of ownership of corporate PCs by centralizing maintenance. Instead of having dedicated support people running from PC to PC to fight fires, one-quarter of the people can do twice the work if everything is on the server and employees are only dealing with workstations.

While this alternate vision of the computing future has caused MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> some misgivings, when Larry and Scott talk about a PC without a hard drive or other storage device, it is companies like WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %>, SEAGATE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %>, QUANTUM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QNTM)") else Response.Write("(Nasdaq: QNTM)") end if %> and STORAGE TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: STK)") else Response.Write("(NYSE: STK)") end if %> that actually stand to lose the most. These companies currently generate the majority of their net revenues by selling rigid drives measuring 3.5 inches, the standard size for a desktop PC. With 87.2 million of these units sold in 1997, it is clear that if anyone stands to lose if corporate America adopts the network computer, it is the people selling rigid drives, not a software company like Microsoft that also wants to run your server.

The storage industry has undergone massive consolidation in the past decade. More than 50 companies made hard drives a little more than a decade ago. Currently there are only 11 suppliers left, with just a handful of those accounting for more than 80% of the total drives sold. With the devastating wars for market share behind them, drive companies have begun managing the storage industry as a business, not as a pell-mell drive for market share. The company doing the most to reform corporate governance of storage companies has been Western Digital, whose shares are up from $17 a year ago to their current perch at $76 7/8, up $5 3/4 today. Understanding that all of its improvements to the business could be wiped out by the adoption of the network computer, Western Digital is striking back with a technology it calls SDX.

SDX, or storage drive acceleration, is a software development that allows the hard drive to become the data management device for the desktop PC. Instead of having the hard drive and separate storage devices like a CD-ROM drive, a removable drive, or a microfloppy drive all communicating with the computer, SDX allows the hard drive itself to directly go and grab information from the other peripherals. By allowing the peripherals to bypass the computer, you can load stuff faster and more efficiently "cache," or store, information from a CD or microfloppy on empty space on the hard drive. SDX potentially changes the debate about what should and should not go in the network computer by offering greater performance for any information that you would access with a peripheral drive -- particularly a CD-ROM player.

SDX also addresses something that many in the storage industry call the "X" factor dilemma. The name comes from the way CD-ROM speeds are measured, using a number and then the letter X to designate the velocity -- 4X, 8X, 12X, etc. Unbeknownst to many consumers, because multimedia software developers have to ensure that their software is backwards compatible, faster CD-ROM drives rarely translate into faster CD performance. Because the actual CD has to be configured to operate at the higher speed, the supply of CD-ROM software that can actually go at the highest speed possible on new CD-ROMs is very small. The system causes inventories to become rapidly obsolete, creating an unstable business model for the CD-ROM drive makers.

Because SDX improves CD-ROM performance, representing about four years worth of CD-ROM performance improvement, it could eliminate rapid CD-ROM obsolescence. With the CD-ROM manufacturers excited about the technology, Western Digital has approached its cross-license partners (IBM and Seagate) to also implement the technology. Although SDX is a direct assault on the idea of a computer without a hard drive -- something all other hard drive makers can empathize with -- it is also an extension of Western's effort to make reliability and quality just as important as price when it comes to selecting a hard drive. Because Western Digital believes that price alone is not enough to take market share, by emphasizing the performance of the hard drive as a data management device it gets to distinguish itself in a way that otherwise might not be possible.

Western Digital remains one of the most interesting stories in the storage technology universe. After eliminating non-core businesses like semiconductor manufacturing in 1995, the company vaulted to prominence in 1996 by improving earnings and gaining critical market share well above analyst expectations. Although this is in part due to the success of its direct PC manufacturing customers like DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>, GATEWAY 2000 <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GATE)") else Response.Write("(Nasdaq: GATE)") end if %> and MICRON ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MUEI)") else Response.Write("(Nasdaq: MUEI)") end if %>, its superior asset management and improved quality has also played a large role. When Western reported second quarter earnings of $1.36 per share on January 13th, this was 47.8% ahead of consensus estimates at the time. If Western can continue to piggy-back the direct manufacturers and gain market share as well as getting broad support for SDX, then a lot of the potential negatives in the future could be neatly avoided.

Current estimates call for Western to earn $4.68 per share this year and $6.32 per share next year. Given that the company has already made $2.06 per share in the first two quarters, simply repeating the second quarter two more times would put the company at $4.78 per share. Stocking for holiday PC sales certainly drove part of the fiscal second quarter, but given projections of 16% to 20% in PC unit volume growth next year, reproducing this quarter may be entirely possible. Management has already said that Western will come in at the high end of third quarter estimates, which is currently $1.43 per share.

The $6.32 EPS estimate for next year assumes that Western can only improve profits by about 16% in 1998 from the quarterly run-rate established this quarter. This seems conservative given that Western's margins improve as its volume increases due to the high fixed costs and the large investment in plant, property and equipment to produce drives. Finally, the company has been using cash flow to repurchase shares, something that accelerates profit growth even further. In the second quarter, the company bought back 750,000 shares at an average price of $53 -- a pretty savvy investment considering the current price tag, and one that seems likely to continue given the strong cash flow. Trading at only 12 times the low earnings estimate for fiscal 1998, there could be more appreciation left in the stock despite the fact that it has increased five-fold over the past year.

(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool.

© Copyright 1995-2000, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. The Motley Fool is a registered trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us

...

...

...

...

...

...

...

...

...