Seagate Plummets On Revised Earnings

Posted by at 11:25 am on April 15, 2016

Seagate-LogoSeagate announced its dreary preliminary financial information for its fiscal third quarter, which revealed that its HDD unit shipments, and thus revenue, came in well under expectations. The companyshipped 39 million HDDs in the quarter, which represents 40 percent of the HDD market, but it experienced weak demand in several key sectors.

The company adjusted its revenue projections from $2.7 billion to $2.6 billion, and its non-GAAP gross margin from 27 percent to 23 percent. Seagate’s revenue is down 13 percent quarter-over-quarter and 22 percent year-over-year.

The stock market responded immediately in after-hours trading, and as at the time of publication, Seagate’s stock has tumbled 19.8 percent.

Seagate noted that it experienced reduced demand in the desktop PC sector, particularly in China. The PC market has been declining at a rapid pace, but the secular decline is only accelerating as the predicted Windows 10 hardware refreshes never materialized. Global 2015 PC shipments declined by 10.6 percent according to IDC, though Gartner had a rosier prediction of an 8.6 percent decline.

To make matters worse, the PC market declined an additional 9.6 percent in the first quarter of 2016. Gartner still holds out hope that the Windows 10 refresh will occur in the latter half of 2016, but all major analyst firms agree that the PC market will continue to decline until then.

Seagate also indicated that it chose to “not aggressively participate in the low capacity notebook market,” thus suffering a decline in unit shipments in this key sector, as well. HDD manufacturers are limited by a base price of roughly $40 for the key materials required to construct a 2.5″ client HDD. This cost comprises several of the critical HDD components, such as motors, heads and spindles. It is nearly impossible for an HDD to dip below $40, regardless of its capacity.

SSDs, however, can scale price linearly according to the capacity, so an SSD vendor can create a sub-$40 SSD that still features enough capacity for the low-capacity notebook segment. Seagate could theoretically compete in this market, but it would have to price so aggressively that it might actually lose money just to hold market share.

The enterprise has always served as the HDD vendor’s high-margin haven, but SSDs are experiencing even more success in one of the HDD’s few remaining profitable segments. Seagate indicated that its shipments of traditional mission-critical HDD products, which encompass its 2.5″ 10K and 15K offerings, experienced a sharp decline in the quarter. This is not entirely unexpected, as SSDs have been encroaching upon the high-performance HDD space for some time.

SSDs feature lower power consumption, higher performance and more density than their 2.5″ HDD counterparts do, and although they are more expensive than HDDs on a capacity basis, the other factors outweigh the initial cost. If NAND fabrication capacity can keep pace with demand, SSDs are widely expected to supplant 2.5″ HDDs in the near future.

However, the retreating desktop market has also hurt the SSD vendors. Toshiba is restructuring, SanDisk is being sold, and Micron experienced its first quarterly loss in 12 quarters, which is surprising in light of the havoc SSDs are wreaking in the HDD market. The weak demand for SSDs indicates that the cratering PC segment is hurting everyone. When SSD demand returns (which it will), the price of SSDs will increase, thus providing the HDD vendors some breathing room.

The easy answer for the HDD vendors is to retreat into the high-capacity market. HDDs still hold a tremendous advantage in the key dollars-per-GB metric, and SSDs will never be able to compete in this cost-conscious segment. The only bright spot in Seagate’s announcement was that demand for its 8TB enterprise nearline HDDs increased, which indicates that more enterprises are shifting to the cloud. The cloud is growing at a remarkable pace, and satiating its appetite with high-capacity offerings will continue to be a lucrative pursuit moving forward.

“We are disappointed that we did not anticipate the weaker demand in the March quarter. There are many complex issues impacting the traditional go to market channels in our market, which are reducing our forecast visibility. Despite the disruption of the shifts in our traditional mission critical HDD business in the near term, we believe the long term benefit of cloud architectures for end users, and the related need for very high capacity drives, is a net positive for Seagate and the HDD industry,” said Steve Luczo, Chairman and Chief Executive Officer.”

 

Seagate also indicated that it suffered losses in its systems and silicon business. Many do not associate Seagate with the silicon industry, but it did recently purchase SandForce, which has failed to field a new generation of SSD controllers for several years. The current generation of SandForce SSD controllers is outdated, so a decline in that segment will only continue until it fields a new (and competitive) SSD controller.

WD recently purchased SanDisk so that it can expand into the lucrative NAND segment. This key addition will allow WD to adjust to the changing tide of the storage industry. “Embrace SSDs or die” is the tone of the industry at this point, and Seagate will likely purchase a NAND fab. It has a strong strategic alliance with Micron that is beneficial to both companies, but many opine that Seagate will have to dive deeper into the SSD pool to resuscitate its business.

Seagate could choose to purchase Micron (or another fab) in the near future. However, in light of Seagate’s depressed trading value, Micron may actually purchase Seagate. In either case, it is clear that Seagate may have to take bolder steps to survive in the increasingly NAND-powered future

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