A Wall Street Perspective on the HDD Industry

Transcription

1 A Wall Street Perspective on the HDD Industry March 14, 2005 HARRY E. BLOUNT CFA

2 Important Disclosures FOR CURRENT IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS RESEARCH REPORT, PLEASE SEND A WRITTEN REQUEST TO: Lehman Brothers Control Room, 745 Seventh Avenue, 19th floor, New York, NY or refer to the firm's disclosure website at Important Disclosures Lehman Brothers does and seeks to do business with companies covered in research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. The analysts responsible for preparing this report have received compensation based upon various factors including the Firm s total revenues, a portion of which is generated by investment banking activities. Guide to Lehman Brothers Equity Research Rating System Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector ( the sector coverage universe ). In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone. Stock Rating 1 - Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon. 2 - Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12- month investment horizon. 3 - Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12- month investment horizon. RS - Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Lehman Brothers is acting in an advisory capacity in a merger or strategic transaction involving the company. Sector View 1 - Positive - sector coverage universe fundamentals/valuations are improving 2 - Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating 3 - Negative - sector coverage universe fundamentals/valuations are deteriorating 1

3 Agenda Some Macro Trends Where Should HDD Stocks Be Valued? Reasons for Hope? Analysis of Major Competitors 2

4 Public Company Research Coverage Equity Research Excellence Lehman Brothers Sales Force #3 #1 #1 #3 #1 #3 Ranked #1 in 2003 and 2004 All-America Survey, with 51 ranked equity analysts. Lehman moved up from #2 in 2002 and #5 in Back-to-back biggest winning margins in over 20 years. Ranked #1 in 2003 and 2004 in combined Fixed Income and Equity Analysts. Sales Force Ranked #1 among portfolio managers. Sales Force Ranked #1 among hedge funds Personal Computer Enterprise Hardware Enterprise Storage Storage Networking Disk Drives Tape Services Apple Dell HP IBM SUN Dot Hill EMC NTAP Brocade Emulex McData QLogic Maxtor Seagate WDC Quantum StorageTek Akamai Iron Mountain 3

5 Macro Trends

6 IT INFRASTRUCTURE OLDEST IN 20 YEARS Spending YOY (%) 20% Cash as a % of IT company assets at all-time high 15% Arbitrage between cash and valuation most attractive in at least 10 years 10% IMPLICATION: Reduced option overhang and Homeland 5% Investment Act likely to accelerate industry consolidation 0% -5% -10% Average Age (Years) -15% YOY Spending Average Age Source: Lehman Brothers and Bloomberg We Are In The Midst of A Durable IT Spending Cycle 4

7 IT Industry Consolidation Likely in x 6.0x 5.0x 4.0x 3.0x 2.0x 1.0x 0.0x 40% 35% 30% 25% 20% 15% 10% Source: Lehman Brothers and FactSet Median EV/Sales (Lehman Tech Basket) Cash as a % of Total Assets Cash as a % of IT company assets is at a 25 year high Arbitrage between cash and valuation most attractive since the early 1990s IMPLICATION: Slowing growth, declining option overhang and Homeland Investment Act are likely to accelerate M&A activity 5

8 INVENTORY LIQUIDATION NOW COMPLETE 40% 30% Cash as a % of IT company assets at all-time high Arbitrage between cash and valuation most 20% attractive in at least 10 years IMPLICATION: Reduced option overhang and 10% Homeland Investment Act likely to accelerate industry consolidation 0% -10% Jan-94 May-94 Sep-94 Jan-95 May-95 Sep-95 Jan-96 May-96 Sep-96 Jan-97 May-97 Sep-97 Jan-98 May-98 Sep-98 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05-20% -30% -40% New Orders Y/Y % Growth Source: NAICS and Lehman Brothers Inventories Y/Y % Growth IT Demand Similar to 1990s Inventory Liquidation Has Largely Been Completed Pricing power shifting back to component suppliers??? 6

9 PC/CE Convergence

10 Enterprise Hardware Growth Rates E CAGR % Desktop $100.5 $ % Notebook $56.4 $ % Total PCs $156.9 $ % Only 2 segments of enterprise hardware are projected to grow at rates of 10% or more: Notebook PCs Network Storage x86 servers $19.6 $ % Other servers $26.5 $ % Total servers $46.1 $ % DAS $5.9 $ % SAN/NAS $8.6 $ % Total Storage $14.5 $ % Inkjet $11.3 $ % Laser $31.2 $ % Total printers $42.5 $ % Total IT HW $260.0 $ % Source: IDC, Lehman estimates 7

11 This Should Be A Good Business Tech Sectors - Projected Long Term Growth Servers 3.0% PCs 4.6% Hard Drives 5.0% Storage (External) 5.3% Microprocessors 6.6% Data Networking 10.0% Source: Lehman Brothers, IDC, and First Call 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 8

12 This Should Be A Good Business MXO 8% MXO -2% HDD Avg 15% Gross Margins, 4Q04 SUNW 1% Operating Margins, 4Q04 WDC 16% HDD Avg 4% DELL 19% WDC 6% STX 21% STX 8% SUNW 42% DELL 9% EMC 52% EMC 16% INTC 55% CSCO 35% CSCO 66% INTC 42% 0% 10% 20% 30% 40% 50% 60% 70% -10% 0% 10% 20% 30% 40% 50% Source: Company filings 9

13 This Should Be A Good Business MXO -7% Return on Assets (TTM) HDD Avg 5% STX 8% WDC 14% SUNW -2% EMC 6% DELL 15% CSCO 16% Source: Lehman Brothers based on company financials INTC 16% -10% -5% 0% 5% 10% 15% 20% 10

14 This Should Be A Good Business TTM Capex and R&D as a % of Revenue Source: Lehman Brothers DELL 2% W DC 12% MXO 14% HDD Avg. 15% EMC 15% CSCO 17% SUNW 19% STX 20% INTC 25% 0% 5% 10% 15% 20% 25% 30% 11

15 Dell versus HDD Stock Performance Price/Earnings Ratio (Dell vs. HDD Industry) Dell E Source: Lehman Brothers HDD Avg.

16 Dell versus HDD Stock Performance EV/Sales (Dell vs. HDD Industry) Dell HDD Avg E Source: Lehman Brothers 13

17 PC/CE Convergence

18 No Revenue Growth in 7 Years $ Billions CAGR % Seagate $7.3 $ % Western Digital $4.3 $ % Maxtor $1.4 $ % Hitachi $0.4 $ % Samsung $0.7 $ % Fujitsu $2.3 $ % Toshiba $1.8 $ % Other $13.6 $ % Totals $31.8 $ % Top 4 Revenue $24 $17-4.6% Top 4 Suppliers 75.8% 76.1% Pure Merchant Share 58.8% 56.7% Source: IDC 14

19 Margins Remain Volatile 30% 25% 20% 15% 10% 5% 0% -5% -10% HDD Gross and Oper Margins 6/ /1992 6/ /1993 6/ /1994 6/ /1995 6/ /1996 6/ /1997 6/ /1998 6/ /1999 6/ /2000 6/ /2001 6/ /2002 6/ /2003 6/ /2004 Gross Profit Oper. Margin Source: Lehman Brothers 15

20 HDD vs. Components Stock Performance Component Avg. (HTCH & KOMG) HDD Avg. (MXO, STX & WDC) S&P

21 INDUSTRY OUTLOOK

22 MIXED OUTLOOK - BUT REASONS FOR HOPE METRIC PAST FUTURE CUSTOMER BASE CONCENTRATED DIVERSIFYING PRODUCT SEGMENTATION LIMITED INCREASING PRODUCT BREADTH LIMITED COMPETITION BY SEGMENT EXPANDING PRODUCT PORTFOLIOS SUGGEST DECLINING MARGINS CHANNEL PRACTICES 6-8 WEEKS 4-6 WEEKS INDUSTRY PROFITABILITY MULTIPLE COMPANIES 2-3 COMPANIES MARKET CONSOLIDATION NO PROGRESS SINCE QUANTUM-MAXTOR LIKELIHOOD INCREASING ACCOUNTING AND DISCLOSURES SELL-IN ACCOUNTING MIXED LEVEL OF DISCLOSURE 17 NO PROGRESS MIXED LEVEL OF DISCLOSURE

23 Analysis of Competitors COMPANY STRENGTH VULNERABILITY Fujitsu Strong parent Position in 2.5 and below Scale Competitive pressure HGST Maxtor Scale Breadth Strong parent Scale Position in high capacity Execution High cap dependency No 2.5 and below Balance Sheet Samsung Strong parent Reliance on 3.5 Scale Seagate Scale/Breadth Grew Addressable Market Profitability Fibre channel exposure Toshiba Prowess in 2.5 and below Scale Increased competition Western Digital Execution Grew Addressable Market 18 Reliance on 3.5 Head integration benefits nearly complete

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