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Seagate Stumbles to Conquer

By Peter Burrows It looks like corporate server buyers came to Seagate's (STX) rescue -- just in time to limit the damage from the disk-drive maker's miscues in the PC market. Although the Scots Valley (Calif.) outfit announced disappointing sales of drives for desktop PCs, it said during a midquarter update on Sept. 7 that it was raising its revenue target for the quarter that ends Sept. 31. The stock rose 3.8%, to $12.32, on the news.

What gives? Clearly, Seagate is being hit by a bit of a hiccup in desktop PC sales -- a trend cited by Intel (INTC) when it downgraded its quarterly expectations during a conference call on Sept. 2. While big brand-name PC manufacturers are continuing to buy at the expected rate, Seagate said sales to "channel" partners such as tech distributors are running flat compared to the second quarter. That's bad news, since drive sales usually improve in the third quarter, thanks to back-to-school sales and the buildup before the Christmas season.

BALLOONING INVENTORIES. Fortunately for Seagate, sales of drives used in high-end servers and storage banks, as well as consumer gizmos such as TiVo-style personal video recorders and game consoles, more than compensated for the consumer softness in other products. What's more, the outfit said prices would drop only 3% to 4% in the quarter, rather than the expected 5%, largely because it has been able to hold prices steady for the high-capacity server drives. "The company appears to be gaining meaningful share in the [corporate] market," wrote Needham analyst Richard Kugele in a Sept. 7 report.

This must be tough medicine for Seagate's rivals, since it seems the company may not be penalized for a series of missteps in recent quarters that hurt the entire industry. Late last year, say critics, Seagate flooded the market with drives in order to take more than its share of an expected uptick in PC and server demand, particularly with those distribution partners. When the growth didn't hit Seagate's expectations, its "channel inventories" ballooned.

That forced Seagate to slash prices, leading it to temporarily fall into the red. In the spring, the outfit again built far too many drives, this time for notebook models, analysts say.

Such stumbles are the kiss of death in the hypercompetitive drive industry. Indeed, if having boatloads of old fish or blackening bananas is bad news for fisherman and farmers, excess stocks are just as disastrous for drive makers, if not more so. After all, they pour millions into designing and building drives that can hold more and more data each year. Yet these technical wonders can command a premium price for just a few months before new, improved models make them obsolete.

MORE GOOD THAN BAD. Seagate's actions may have helped drag the entire drive business into trouble, analysts contend. Faced with the prospect of letting Seagate gain market share, rivals such as Maxtor (MXO) and Western Digital (WDC) decided to slash their own prices as well. While Seagate's stock has dropped from $25 a year ago to just over $12 today, shares in Western Digital have slumped from $11.86 to $8.14, while Maxtor has nosedived from $11.50 to $5.

Maxtor, however, seems to be suffering from quality-related issues involving some high-end drives that could inflict a more lasting wound. Maxtor couldn't be reached for comment. Says Kugele: "In general, I think companies are more stigmatized for quality issues than for stuffing the channel, which could be attributed to every company at one time or another."

Seagate's most recent upbeat news is more good than bad for the tech industry generally. As the only drive maker whose wares go into products from PDAs to mainframes, it's a tech bellwether. Should corporate spending be on the rise, that's good news for most tech suppliers, since sales to companies are generally more profitable than those to consumers.

"DARWINISM WORKS." Furthermore, despite last year's miscues, investors seem willing to believe things will work out O.K. for Seagate this year. Having tightened up on inventory, it now maintains just three weeks or so of stocks at any given moment, vs. an industry average of five weeks, writes Needham's Kugele. Seagate is also expected to announce some key new products in time for the Christmas season.

As a result, if demand does pick up beyond expectations, Seagate would be well-positioned to work through aging stocks and start selling more profitable new models. "Darwinism works," says Steve Duplessie, founder of the Enterprise Strategy Group, a storage market research firm. "Whether it's luck or skill, the bottom line is their main competitor on the [desktop] side is sucking wind trying to move upstream into the [corporate market], and that's the market that's hitting on all cylinders right now." What's that old saw, about how it's better to be lucky than good? Burrows is BusinessWeek's Computer editor in Silicon Valley

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