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Tuesday, February
24, 1998
Read-Rite Corp.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RDRT)") else Response.Write("(Nasdaq: RDRT)") end if %>
Phone: 408-262-6700
Website: http://www.readrite.com
Price (2/23/98): $13 7/8
HOW DID IT FIND TROUBLE?
Reading, writing, and arithmetic may go together, but the numbers just have
not been adding up for computer disk drive head supplier Read-Rite. General
chaos in the disk drive industry following turmoil in Asia has led to
price-cutting and a rapid technology transition by key Read-Rite customer
Western Digital <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %>. As special charges have stacked up, this
head maker has found itself on the chopping block.
The shares started drifting down from the August high of $30 as investors
worried that excess inventories at industry bellwether Seagate <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %> meant component suppliers would start feeling price pressures. The October
market meltdown sank the stock below $20, where it's pretty much stayed.
On November 7, Read-Rite echoed sentiments expressed by Western Digital,
saying that it would accelerate its transition to higher performance
magnetoresistive (MR) head technology while cutting its production of inductive
thin film heads for the 1.3 gigabyte market. This combo meant the firm would
miss revenue and earnings estimates for the December quarter and be forced
to take a $30 million charge on its inductive technology.
Then Singapore Technologies announced that its Micropolis subsidiary, one
of Read-Rite's minor customers, was being liquidated. Read-Rite was forced
to reserve $15 million to account for receivables, inventories, and other
Micropolis-related exposures.
On January 5, Read-Rite announced that shipments for the last two weeks of
December were even weaker than expected, resulting in first quarter sales
of $261 million. That was only slightly above year-ago levels and well below
fourth quarter revenues of $318 million. Plus, the transition to MR was forcing
additional charges. Actual results reported January 21 showed an after-tax
charge of $91.8 million and operating earnings of just $0.02 a share.
BUSINESS DESCRIPTION
Read-Rite is the world's largest independent supplier of magnetic recording
heads. These heads hover just a microinch above a computer's hard disk drive
platter, reading and writing data. The company designs and manufactures heads
as head gimbal assemblies (HGAs), which include a magnetic recording head
attached to a suspension arm and a wire/tubing assembly. Most HGAs are sold
as headstack assemblies (HSAs), a combo of several HGAs (2 to 8) with other
third-party components.
Although its products are used mainly in 3.5" disk drives (98% of sales),
the company believes it supplies a broader range of drive products (52 in
1997) than any other independent supplier. On the other hand, its 107 million
HGAs sold last year went to just six customers, with Western Digital,
Quantum <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QNTM)") else Response.Write("(Nasdaq: QNTM)") end if %>, and Maxtor accounting for most of its revenues
(51%, 18%, and 13%, respectively versus 43%, 29%, and 12% for FY96).
The shift to higher performance MR head technology should be dramatic. In
FY97, Read-Rite sold 24 million MR heads, increasing MR product sales to
$280 million (24% of revenues) from just $34 million the year before. MR
products should account for the majority of sales in FY98.
Competitors include Japanese firms TDK/SAE and Yamaha and U.S. companies
such as Applied Magnetics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APM)") else Response.Write("(NYSE: APM)") end if %> and the internal head operations
of drive manufacturers such as Seagate and IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %>. In November,
IBM announced that it was expanding its manufacturing operations to include
a giant MR (GMR) program that would produce heads for next generation 3.2
to 16.8 gigabyte products.
The company has manufacturing operations in California, Japan, Thailand,
Malaysia, the Philippines, and Singapore, employing some 24,500 people. Insiders
own about 4% of the stock.
FINANCIAL FACTS
Income Statement
12-month sales: $1,171.9 million
12-month income: $88 million*
12-month EPS: $1.81*
Profit Margin: 7.5%*
Market Cap: $729 million
(*Excludes all charges: $1.9 million for debt pre-payment; $14.8 million
Micropolis loss reserve; $92 million reserve for inductive head phase-out)
Balance Sheet
Cash: $227.5 million
Current Assets: $458.5 million
Current Liabilities: $211 million
Long-term Debt: $417 million
Ratios
Price-to-earnings: 7.7
Price-to-sales: 0.62
HOW COULD YOU HAVE SEEN IT COMING?
In May, Quantum formed a joint venture with its primary Japanese manufacturing
partner, Matsushita Kotobuki Electronics (MKE), to make MR recording heads
for its drives. This represented the latest move by Quantum to find another
head source and prefigured Read-Rite getting locked out of Quantum's 2.1
gigabyte drive program.
Read-Rite was thus hugely and increasingly dependent on
Western
Digital, a major risk for any supplier. Also, both were slower than others
in the industry to transition to MR technology. Had the pricing environment
held up, that might have been no problem. But Seagate's inventory troubles
and the ensuing price slashing by Fujitsu, exacerbated by the Asian financial
crisis, spelled trouble. As a rapid and costly shift to MR became inevitable,
inventory write-offs loomed.
WHERE TO FROM HERE?
Sales to Quantum won't be significant during the first nine months of
FY98. And analysts see substantial losses for Western Digital through at
least the next two quarters. Both are major negatives for Read-Rite. Meanwhile,
the firm's capital expenditures this year will run $250 to $300 million.
Moreover, HSA sales have accounted for a growing portion of Read-Rite's total
sales (67% last year, up from 57% in FY96). Because HSAs consist of a bunch
of purchased components, they carry much lower gross margins for Read-Rite
than do the plain old HGAs. Plus, tough industry pricing overall is expected
to persist for several quarters. So Read-Rite is due for a lot of near-term
pain.
The analysts have basically written off FY98. Earnings estimates of $2.56
a share three months ago have been slashed, with the real consensus revision
probably close to the worst-case projection of a loss of $0.84 per share.
Analysts are looking for a recovery thereafter to $1.00 per share or more
for FY99.
The good news is that the market has now squarely adopted MR technology,
and Read-Rite is coming along. In the first quarter (ended in December),
MR heads accounted for 46% of sales. Moreover, Western Digital expects to
see 80% of its products using MR technology by the June quarter (up from
20% in the December quarter).
That suggests that Read-Rite's overall sales should move rapidly to MR over
the next few months. Plus, Western Digital's near-term dependence on Read-Rite
for supply may support gross margins for now. Read-Rite also has been qualified
as a suppler by five customers for the next generation 2.8 gigabyte MR heads.
Investors looking for a beaten-down play in the disk drive industry should
include Read-Rite among the candidates. On the other hand, the company's
even greater dependence on its current customers suggests that it may prove
a laggard in a recovery.
-- Louis Corrigan
([email protected])
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