Seagate: Is the Tide Still Rising?
Talk about driving a hard bargain. Back on Nov. 22, 2000, as the Silicon Valley-Wall Street edifice was shaking in a way that left the Bay Area nostalgic for the 1989 earthquake, a group of private equity firms stepped up to take Seagate Technology (STX ) private. The buyout valued Seagate, a veteran of the computer hard-disk-drive wars, at a bit over $1.8 billion.
Two years and 19 days later, Seagate came public again at $12 a share, revaluing the company at $5.5 billion. Its backers, including Silver Lake Partners and Texas Pacific Group, wound up recouping their entire original investment -- while keeping 82% of Seagate. Nice work if you can get it.
Now, seven months farther down the road, the private equity boys await one more payday. They hope soon to sell an additional 60 million Seagate shares in a secondary offering led by Morgan Stanley. If the shares go at Seagate's recent price above $20 a share, Seagate's backers will take home $1.1 billion or so -- and still hold 68% of the stock, worth about $6 billion. Along with unremitting envy, all of this engenders in me one question: Can any up-side be left?
The answer, improbably, may be yes. While the easy money is long gone, Seagate at $20 is no lunatic's proposition. I say this first because, although Seagate's market value now tops $9 billion, it remains a ghost among individual investors: Neither Morningstar, nor Standard & Poor's, nor Value Line (VALU ) follows the stock. Each of these research services tracks Seagate's leading, yet far smaller, publicly traded rival, Western Digital (WDC ). Eventually, the disparity will be resolved, focusing more investors on Seagate's position -- and potential.
More important, business at Seagate is pretty good today and likely to get better tomorrow. Revenue in fiscal 2003, ended June 27, grew to $6.5 billion, up from $6.1 billion in fiscal 2002. Net income jumped to $631 million from $153 million, in part because consolidation led to slower price-cutting. With a 29% share, Seagate already is No. 1 in the overall market for hard-disk drives, but it remains ambitious. It aims to get more Seagate drives into such increasingly popular consumer electronics as video recorders, and it now is rivaling Western Digital as a supplier of drives for Microsoft's Xbox. In June, it also introduced Momentus, a 2.5-inch drive for notebook computers, a new arena for Seagate. This time next year, it hopes to have a 10% share of that market.
As you would expect, others stand in its way. Hitachi (HIT ) Global Storage Technologies (HGST), formed this year when Hitachi and IBM merged their hard-disk-drive units, is the leader in notebook drives. Bill Healy, who is in charge of this part of HGST, wonders whether any rival, absent a leap forward in technology, could steal that much share that fast. Just the same, Momentus could prove unusually beneficial to Seagate. That's because, unlike most corners of the disk-drive world, where price-cutting is the norm, HGST in May actually hiked prices an average of 5% on its 40-gigabyte, 2.5-inch drives. Healy told me the higher prices have stuck. "We had no significant orders cancelled," he said. "Our business is running extremely strong, even after that price increase." This figures to raise a price umbrella over Momentus.
What about the gigaprofits already taken by Seagate's private-equity investors? Is there more to reap? If hardly depressed, Seagate's valuation still strikes me as moderate. At $20, the stock goes for 13 times the company's estimate of fiscal 2004 earnings. True, that is a higher multiple than Western Digital's 12, but Seagate is much larger, and each drive it sells brings in more revenue and profit than do Western's drives (table). The stock also trades at a discount to the Standard & Poor's 500-stock index, which commands 17 times the next 12 months' earnings. Whose prospects look better now, the broad market's or Seagate's? Seagate's.