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A Gold Rush in Little Hard Disks

By Olga Kharif For several years now, hard-disk-drive makers have boogied to the iPod beat. Apple's (AAPL) best-seller and other MP3 digital music players have sent sales of the smallest disks -- required if you want to store thousands of songs on your portable music player -- to the top of the charts.

Soon storage makers will be hearing more sweet music: The next generation of cell phones from Samsung and Nokia (NOK) will be sporting hard drives. Unlike prior models that stored just a handful of songs on a phone's flash memory, these models will have as much capacity -- eventually more -- as your average MP3 player.

SAMSUNG'S FIRST. Used for storing thousands of music tracks, personal health records, credit-card data, photos, even TV shows, they could even eclipse in popularity the blockbuster camera phones.

"There's a tremendous amount of carrier interest in this," says Bob Shallow, director of rich media and music for Nokia, which will release its first hard-drive-based mobile phone in the fourth quarter. Samsung recently introduced a hard-drive cell phone in Korea but hasn't disclosed plans for a worldwide rollout.

Hard-drive makers like Seagate (STX), Toshiba, Hitachi Global Storage Technologies, and Western Digital (WDC) could be in for a growth spurt surpassing the MP3 player craze. In 2008, about 80 million mobile phones (a modest 10% of all cell phones shipped) will feature hard drives, up from zero today, according to Bill Healy, Hitachi Global Storage's senior vice-president for product strategy and marketing. To put this in perspective: The installed base of MP3 players will reach 54.1 million units by the end of the decade, predicts consultancy Jupiter Research.

UNTAPPED MARKET. And Hitachi is hardly the most aggressive forecaster out there. Seagate, the world's largest manufacturer of disk drives, believes that up to 30% of all cell phones shipped will have hard drives in two to fours years, says Brian Dexheimer, executive vice-president for global sales and marketing. If that's the case, sales of such cell phones will exceed those of PCs, which have long been the biggest consumers of storage.

This tremendous growth opportunity is causing a gold rush into the small-size hard-drive market. Storage maker Maxtor (MXO) is preparing to release its first one-inch drive. And startups like Cornice are specializing in the smaller drives, used in everything from cell phones to TVs.

Hard-drive component vendors including Marvell (MRVL) should benefit from this stampede as well. "It's one of the key areas of focus for the company," says Mike Tate, treasurer at Marvell, whose chips go into the disk drives that eventually make it into the Apple iPod.

FATTER MARGINS. But it's not just sales growth that's making these companies see green. The tiny drives have big profit margins. Already, Seagate's gross margins have risen from 17.7% in September to 24.2% in March -- a trend that's due in large part to fat profits on its little disk drives for MP3 players, says Brent Bracelin, an analyst with Pacific Crest Securities in Portland, Ore.

With the introduction of cell phones containing hard disks, demand for the smaller drives should surge. As a result, current supply constraints should last for months and push the manufacturers' margins even higher, he believes.

To meet growing demand for the smaller drives for consumer electronics, Seagate already has upped its capital spending by 40%, to $700 million, for the current fiscal year, ending in July.

The first hard-drive phones, likely to appear in the U.S. in late 2005 or early 2006, could cost more than $400, believes Krishna Chandler, an analyst with iSuppli. However, most analysts expect that U.S carriers will subsidize the cost and offer consumers a lower-priced unit.

TRAINING WHEELS. Here's why: Cell phones with hard drives could help wireless service providers increase their customers' data usage. The carriers want consumers to download songs from their networks, thus using more wireless minutes each month. The problem is that consumers aren't accustomed to doing this.

The new phones could act as training wheels by allowing people to upload songs from their PCs, the way they already do with MP3 players, says Nokia's Shallow. The expectation is that consumers eventually will start downloading songs wirelessly. By that time, hard-drive technology should improve, too.

Today, the disks eat up about twice the battery power of flash memory, and they're more fragile, says iSuppli's Chandler. That's why companies like Intel (INTC), a major producer of flash memory, say that flash, removable cards, and other types of storage offering much less capacity than hard drives will rule the cell-phone market. After all, users do just fine with the iPod Shuffle, which stores all its songs on flash memory. "Average users just want their phone to be a phone, not an MP3 player," says Darin Billerbeck, general manager for flash at Intel.

Chances are this market will be big enough for everybody, though. As users begin to store an increasing amount of information on their mobiles, hard drives could become a necessity. In fact, Nokia's research into various storage formats has found them to be "the best overall alternative," says Shallow. Hard-drive makers might be just entering their grooviest times yet. With Peter Burrows in in San Mateo, Calif.

Kharif is a reporter for BusinessWeek Online in Portland, Ore.

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