Seagate Technology Plc Company Analysis - Essay Example

? Seagate Technology (Company Analysis) 08 April Executive Summary This research paper is on the company Seagate Technology (STX) which is the leading maker of hard disk drives in the world today. This paper is divided into four main sections. The first section deals with the chief purpose of this paper which is to examine Seagate and determine whether it is a good investment vehicle considering the nature of its industry. It also gives a short overview of the firm to give a reader some idea what the firm is all about. In the next section, a more comprehensive analysis is rendered considering the whole economy, with both an industry analysis and company analysis as part of the overall analysis of this paper. It included both qualitative and quantitative assessments of the company to have an idea of the various threats and challenges it is currently facing as well as the opportunities in the market. The third section is the conclusion portion of this paper and summarizes what has been stated in previous sections. It also reiterates the important points raised by the company analysis so that a potential investor can make an informed judgment on the company based on facts the paper has presented so far. The fourth and last section is the recommendation which suggests a buy position for the company but only for the medium term investment horizon and further subject to a periodic quarterly review. This is because the very nature of the computer industry is that of rapid technological change and short product life cycles that can render even market leaders with an uncertain viability in a “nightmare moment” (strategic inflection point). Keywords: buybacks, data storage devices, flash memory, hard disks, hard drives, Seagate Table of Contents Section Page Number Executive Summary..…………………………………………………………….......1 A. Introduction............................................................................................................3 A.1 Statement of Purpose…………………………………………………………3 A.2 Brief Company Overview…………………………………………………….3 B. Discussion ………………….………………………………....……..................... 4 B.1 Economic Analysis………….……………...………………………………... 4 B.2. Industry Analysis..……………................................................………………5 B.3. Company Analysis………................................................................................6 B.3.1 History and Other Information.………..........................................………7 B.3.2 Qualitative Fundamentals………………………………………………...8 B.3.2.1 Management Team…………………………………………………8 B.3.2.2 Business Model…………………………………………………….8 B.3.2.3 Competitive Advantage…………………………………………….8 B.3.2.4 Board of Directors…………………………………………………..9 B.3.2.5 Negative Factors…………………………………………………….9 B.3.2.6 Share Buyback Program…………………………………...………10 B.3.3 Quantitative Fundamentals.........................................…………...……....10 B.3.3.1 Balance Sheet (3-year trend)...................................................................11 B.3.3.2 Income Statement (3-year trend).................…………………………....12 C. Conclusion.................................................................................................................13 D. Recommendation.......................................................................................................13 E. Bibliography..........................................................................................................14-16 A. Introduction This paper is a research report on the company Seagate Technology. It concerns about the present industry conditions of the computer hardware sector, its prospects and the issues and challenges facing its key industry players as well. The scope of this report is to give clear insights about the financial condition of Seagate Technology and its potential as an investment compared to other similar firms or other equally attractive companies as alternative. Scope of this report is limited to publicly available information about the company as well as financial data from published sources. Important information will be highlighted to emphasize certain points about the company and its investment prospects for potential investors. A.1 Statement of Purpose – the aim of this research report is to give its readers enough information to make an informed decision on whether to buy its stock for investment purposes or not. Although there are other alternative investment opportunities in the market, the report is focused on Seagate Technology and makes a subsequent recommendation after a thorough evaluation of the company based on a number of internal and external factors. Industry threats as well as opportunities are discussed in some detail; the strengths and weaknesses of the firm are also covered to give a holistic view of the company in terms of its prospects. A.2 Brief Company Overview – Seagate Technology was started in 1979 by Mr. Alan Shugart and four other partners as Shugart Technology and its first products were hard disk drives for personal computers in the early years of the computer industry. It has about 52,600 employees worldwide with gross revenues of about $11.121 billion and profits of around $1.6 billion last year (2010). Since its founding, Seagate Technology has greatly expanded its line of product offerings which are mainly storage devices for anything digital in form; it includes music files, videos, photographs, cartoon animation and even computer games. A focus of the company at present is on its cloud computing storage devices that serve 24/7 data centers. B. Discussion The global economy went into a recession as a direct result of the housing crisis in the United States that spread to other countries. Among the badly-hit industries was the computer hardware industry as spending for information technology was slashed as it is considered as a discretionary spending by most company executives. Many countries have not yet recovered from the said recession with credit markets frozen in which bankers are reluctant to lend out. B. 1 Economic Analysis – the effects of the recession seem to be over as indicated by long-term interest rates starting to inch up again. Monetary authorities are concerned about an inflationary pressure starting to build up with jobs data improving a bit. Short-term rates have remained largely flat so far (Federal Reserve Bank of New York 1) as result of a credit crunch. The global economy is faced with challenges on its road to recovery with persistent risks with some regional markets and a re-balancing of the usual engines of growth. The International Monetary Fund in its semi-annual World Economic Outlook (WEO) report foresees Asia as a leading area for new economic growth because of its surprising resilience while the US is still mired in toxic assets not yet completely written off despite huge bailouts. Europe is currently facing a slow and gradual but uneven growth, with some countries on the verge of bankruptcy (IMF 72) while other regions such as Africa, the Middle East, North Africa and former Soviet states (CIS or Commonwealth of Independent States) registering modest recoveries as well. It can be noted that some advanced Asian economies like Singapore, South Korea and Malaysia have already enjoyed a strong rebound due to their manufacturing sectors benefiting from the strong growth in trade. Their output is already above pre-crisis levels while the US level still is lagging from their pre-crisis output trends. Japanese economists had predicted the economy will see a fall in its gross domestic product (GDP) for the last quarter of 2010 and then crisis struck in the first quarter this year with the triple earthquake, tsunami and nuclear crises. B.2 Industry Analysis – the computer hardware industry is starting to recover from the worldwide recession. Global computer shipments increased by 19.7% in 2010 from about 305 million units in 2009 to the more respectable 366 million units and are expected to rise a little bit more this year. In terms of value, the total number of computer units shipped out amounted to some $245 billion which was a 12% increase from computer spending in 2009. The sector is expected to fully recover this year, with regional markets exhibiting the usual seasonality. Sales growth will be strong in the near term (2-3 years) as home computer sales will pick up and professional demand from big corporations will accelerate due to replacements. Much of this strong growth will be in portable devices such as laptops, netbooks and mobile phones. A new group of computing devices was introduced this year such as next-generation PC tablets. Other sub-sectors include networking hardware such as modems, routers, cards, adapters, hub switches, scanners, video cards, game controllers and USB storage devices. Seagate Technology itself is equally upbeat about its prospects. This was shown by its sudden change of mind regarding the proposed buyout talks it had with several investors such as the private equity groups of KKR (Kohlberg Kravis Roberts) and TPG Capital. The talks had been about a potential takeover bid by these equity buyers in a leveraged buyout scheme. However, the firm found their bid offers a bit too low and the talks collapsed late last year and Seagate Technology regained its confidence in its main market prospects (de la Merced 1). In essence, the firm decided to buy back $2 billion worth of its shares in the market as a strong sign of its improved prospects with a resurgent global economy. Its new-found confidence is probably well justified since 75% of its total gross revenues come from its overseas markets (Hoovers 1) and these foreign markets are well on their way to economic recovery already. It is expected that strong demand will emanate for its hard disk drives (HDD) from makers of personal computers, consumer electronics, mainframes and high-end servers for data storage. B.3 Company Analysis – Seagate Technology has created a global brand name in the 32 years of its corporate existence. Its name is almost synonymous with hard disk drives. This firm has been an industry leader with a number of remarkable firsts: the first company able to ship its 50-millionth hard drive (1993), the first to reach 250 million drives (1999) and in less than a decade, the first to deliver its 1-billionth hard drive (2008). It was the first to produce a 1.5-terabyte hard drive to serve increased demand for digital content storage solutions and in September 2010 was also the first to manufacture the 1.5-TB portable external disk drive. The company is in the forefront of technology innovations in an industry that is used to rapid changes and quick product obsolescence. Its products have become virtual industry standards in terms of high capacity and high performance but power efficient product lines in both compute-intensive enterprise environments as well as in consumer electronics. Its name is associated with proven reliability by its insistence of owning the key components such as heads and media without reliance on third-party suppliers (Seagate.com 1). The company is deeply involved in the next big trend in the computer industry which is cloud computing. It entails the provision of computer application services from a computer network that is always available on a 24-hour basis using virtual servers on the Internet (Knorr & Gruman 1). The main attraction of cloud computing is it is a good value proposition from the end perspective of IT professionals. It can be likened to a virtual reality in conventional outsource services since it increases network capacity or vastly improves computing capabilities without the need for additional investments in IT infrastructure, training new personnel or purchase a licensed software package. Internet computing is still in its early stages but it has attracted the big industry players such as Microsoft (Eksin 1) which plans to spend billions on its strategy for what some experts call as an industry game changer. It is what Andy Grove of Intel terms as the nightmare moment when new technology can make existing ones obsolete (Grove 10). B.3.1 History and Other Information – the firm has its office headquarters located in Scotts Valley in California, USA but is actually incorporated in Dublin, Ireland for taxation purposes. This was the same method it used to reduce its corporate incomes taxes when it was earlier incorporated in the Grand Cayman Islands back in year 2000. Remarkably, the firm has undergone through various owners in its recent past, like when it was taken private by officers of the company together with Silver Lake Partners and the Texas Pacific Group (TPG Capital) which was the same investor group involved in the latest leveraged buyout attempts which did not prosper and propelled the firm to instead engage in the $2 billion share buyback program. The corporate restructuring was done earlier in a two-step restructuring that involved a merger and then a spinoff together with Veritas Software in which Seagate Technology had a $21 billion stake in common stock with the former company (Gilson & Altman 482). Officers of Seagate Technology had believed the market undervalued the entire company and its profit potential by several billions and the corporate financial restructuring was designed to correct this seeming deficiency. There is a lot of academic theoretical literature regarding propriety of using share buybacks as a way to boost share price of a company’s stock. Some of it is very negative since a buyback tends to send a wrong signal to the market. Some financial and market experts view share buybacks indicative of management’s faith and confidence in its own plans and prospects in which it invests in its own stock. This implies, however, a deeper meaning, which is that management cannot find new profitable ventures in which to invest its excess cash for future investments that generate revenues. It can be likened to a case of engaging in accounting tricks to boost price per share of its stock (Pettit 1). This happens when there are less shares of stock outstanding for the same income, producing higher earnings per share (EPS). Buybacks also alter the debt-equity ratio (D/E) of a firm and raises its risk profile especially in a technology-heavy sector such as computers. B.3.2 Qualitative Fundamentals – this section deals and explores some of the factors that gave Seagate Technology its competitive advantage in a high-growth and fast-changing sector of a global industry. This discussion tries to encapsulate some of crucial information that cannot be captured by looking into the financial statements alone and gives the readers an insight into the overall prospects of the company, its challenges and opportunities. B.3.2.1 Management Team – the people at the helm of Seagate Technology are very seasoned professionals and come with a lot of expertise and experience in their specialties. The present chairman is Mr. Stephen J. Luczo who is knowledgeable in the computer industry as he came from the Global Technology Group of the investment banking firm of Bear, Sterns & Co. Inc. The three executive vice presidents of the company are Mr. Bob Whitmore (EVP-CTO), Mr. Dave Mosley (EVP-Sales & Marketing) and Mr. Patrick O’Malley (EVP-CFO) all comes with impressive backgrounds. The rest of the executive team is of full-qualified people. B.3.2.2 Business Model – the firm is a believer in the concept of time-to-market approaches in its product launches. This is very crucial in the industry where product life cycles are short. It was a rude awakening for the company as it revamped its business model of first-to-market in an industry where it used to be the only supplier (InfoWorld 14) but now has two formidable competitors: IBM and Fujitsu. It cannot afford to be late with products. B.3.2.3 Competitive Advantage – it derives its strength from its lean manufacturing (Boogar 96). It means it puts emphasis on manufacturing excellence that puts its product lines in time-to-market volumes without sacrificing quality and price. Its company culture is to use technology to solve problems which are factual and that using physics will eventually resolve its technical difficulties (Hughes 164). Furthermore, it had mastered the art of mass producing disk drives by not resorting to outsourcing its production. This strict adherence to excellence is seen in its use of green technology in product design and development. B.3.2.4 Board of Directors – the company’s board is headed by Mr. Luczo as chairman with eight other directors of impeccable integrity. Its corporate governance policies are in place with various committees such as compensation, nominating and corporate governance. The firm’s board is composed of well respected people in the industry who have competencies and skill sets to bring to their jobs in the interest of all its stakeholders. The directors see to it the company complies fairly and honestly with all regulations as well as to ethical standards. B.3.2.5 Negative Factors – the triple threats to Seagate Technology are flash memory cards, commoditization and the upcoming cloud technology. Flash memory refers to the new technology in small storage devices in which data can be electronically erased, reprogrammed and has an ability to retain data even without power. Flash cards are very portable and used in a variety of mobile devices like cellular phones, digital cameras, MP3 players, iPads, laptops, notebooks, netbooks, game consoles and other consumer electronics products like DVRs. The market is moving towards undifferentiated price commodities from being branded names. Seagate Technology has been slow to enter this new market just like what happened in the past when it initially resisted the migration to the smaller 3.5” disks from the 5.25” disks. Its main product line is also under siege from new industry players such as Toshiba, Hitachi, Western Digital Corporation (WDC), SanDisk, Quantum and Imation (Farrell 1), including Maxtor (acquired in 2006). These new players tested the capability of Seagate Technology through pricing pressures that resulted in a more intense competitive environment and even in irrational pricing behavior. It is exemplified by the captive hard disk manufacturers such as Samsung which is a diversified firm with a hard drive division. It can then sell these disks at break-even costs or even at a loss since it can be bundled with its more profitable components. Although cloud computing is a positive for storage data makers, Seagate Technology was also slow to move into this new market segment that will reach $6 billion in 2013 (Perdue 1). B.3.2.6 Share Buyback Program – the company had embarked on a $2 billion share buyback despite the negative literature on most buyback initiatives in the past. Although management can always put a positive spin to it, such endeavors almost always send a negative signal to the market. What it implies is that it cannot invest excess cash profitably so it will instead return the money to investors (Higgins 109) and this practice of either paying dividends or re-purchasing its own shares hints of a management failure. More specifically, it points to an inability to perform a basic managerial function of profitably investing capital. B.3.3 Quantitative Fundamentals – this section examines the financial data of the firm and will be used as basis for deciding on the proper investment recommendation to be made. The company's published financial statements will be used for this purpose and includes some ratios that will help determine the financial health of Seagate Technology. Figure 1: Latest Intra-day Trade in Seagate Technology (NASDAQ Symbol - STX) Source: Hoover's.com (as of April 06, 2011) EPS = $2.37 52-week (high/low) = $20.90 - $ 9.84 P/E Ratio = 6.23 Average Volume = 6.72 million shares Expected Return = 16% P/E Growth (5-yr expected) = 2.53 Market Cap = $6.686 billion Analyst Recommendation: HOLD B.3.3.1 Balance Sheets – the company operates on a fiscal year ending in June. This company's gross, operating and profit margins are slightly above industry averages. Its price-to-book value is also higher 1.89x compared to the industry's 1.32x which indicates a higher demand for STX shares in the stock market. The financial strength of Seagate Technology is its very low gearing with a debt-equity ratio of only 80% which means it is very conservative. This is proven by its high quick ratio of 14x and a current ratio of 1.83x (Daily Finance 1); in other words, the company has so much cash it can afford to spend $2 billion to buy its shares. Figure 2: 3-Year Balance Sheets (ending June 2010, 2009 and 2008) Assets June 2010 June 2009 June 2008 Current Assets Cash 2,263.0 (27%) 1,427.0 (20%) 990.0 (10%) Net Receivables 1,400.0 (17%) 1,033.0 (15%) 1,410.0 (14%) Inventories 757.0 (9%) 587.0 (8%) 945.0 (9%) Other Current Assets 998.0 (12%) 1,244.0 (18%) 927.0 (9%) Total Current Assets 5,418.0 (66%) 4,291.0 (61%) 4,272.0 (42%) Net Fixed Assets 2,263.0 (27%) 2,229.0 (31%) 2,464.0 (24%) Other Non-current Assets 566.0 (7%) 567.0 (8%) 3,384.0 (33%) Total Assets 8,247.0 (100%) 7,087.0 (100%) 10,120.0 (100%) Liabilities June 2010 June 2009 June 2008 Current Liabilities Accounts Payable 1,780.0 (22%) 1,573.0 (22%) 1,652.0 (16%) Short-Term Debt 329.0 (4%) 771.0 (11%) 360.0 (4%) Other Current Liabilities 888.0 (11%) 850.0 (12%) 1,275.0 (13%) Total Current Liabilities 2,997.0 (36%) 3,194.0 (45%) 3,287.0 (33%) Long-Term Debt 2,173.0 (27%) 1,956.0 (28%) 1,670.0 (17%) Other Non-current Liabilities 353.0 (5%) 413.0 (6%) 577.0 (6%) Total Liabilities 5,523.0 (67%) 5,563.0 (78%) 5,534.0 (55%) Shareholder's Equity Common Stock Equity 2,724.0 (33%) 1,524.0 (22%) 4,586.0 (45%) Total Equity 2,724.0 (33%) 1,524.0 (22%) 4.586.0 (45%) Shares Outstanding (thou.) 452,967.8 452,967.8 452,967.8 Source: Hoover's.com (rounded off to nearest percent). This is a vertical analysis based on total assets. B.3.3.2 Income Statements – the firm's income statement over a three-year period is a remarkable turnaround from the depths of the recession to pre-crisis levels of sales revenues. Its sales increased by 16% in 2010 from the year earlier but its profit gross profit margin was doubled in the same period due to serious cost-cutting measures. It was able to swing from a loss in 2009 to respectable profitable operations a year later with a rebound in the economy. It is an impressive performance by top management considering that Seagate Technology is an independent manufacturer of disk drives as opposed to captive makers like Samsung. Increase in profits are due to the stronger market presence with the acquisition of Maxtor back in 2006 and most redundant costs have now been eliminated. Its total market share is now about 47%. Figure 3: 3-year Income Statements (horizontal analysis) FI June 2010 June 2009 June 2008 Revenue 11,395.0 (116%) 9,805.0 (77%) 12,708.0 Cost of Goods Sold 8,191.0 (98%) 8,395.0 (88%) 9,503.0 Gross Profit 3,204.0 (227%) 1,410.0 (44%) 3,205.0 Gross Profit Margin 28.10% (195%) 14.4% (57%) 25.2% SG&A Expense 437.0 (81%) 537.0 (81%) 659.0 Depreciation & Amortization 27.0 (49%) 55.0 (102%) 54.0 Operating Income 1,740.0 (166%) (2,635.0) (-291%) 1,376.0 Operating Margin 15.3% (157%) -26.9% (-349%) 10.8% Non-operating Income (3.0) (13%) (23.0) (-204%) 22.0 Non-operating Expenses (168.0) (144%) (117.0) -- Income Before Taxes 1,569.0 (157%) (2,775.0) (-308%) 1,329.0 Income Taxes (40.0) (-112%) 311.0 (464%) 67.0 Net Income After Taxes 1,609.0 (152%) (3,086.0) (-345%) 1,262.0 Continuing Operations 1,609.0 (152%) (3,086.0) (-345%) 1,262.0 Discontinued Operations -- -- -- Total Operations 1,609.0 (152%) (3,086.0) (-345%) 1,262.0 Total Net Income 1,609.0 (152%) (3,086.0) (-345%) 1,262.0 Net Profit Margin 14.1% (145%) -31.5% (-419%) 9.9% Diluted EPS from Total Net Income 3.14 (150%) (6.32) (-368%) 2.36 Source: Hoover's.com (2008 is base year for 2009 while 2009 is divisor for year 2010) C. Conclusion Seagate Technology is in the data storage devices sub-sector of the computer industry. The rebound in the global economy bodes well for the company as it markets 75% of its total production to foreign markets where demand is still strong especially in desk top PCs which is suffering a slowdown in the developed markets of the US and Europe. Additionally, its growth targets are threatened by the increased use of flash memory cards in many portable devices. A flash card is a solid-state storage device (no moving parts) and therefore less likely to break; it also uses less power. The main barrier of flash cards is their price but this is brought down by advances in manufacturing technology and other technical problems are also being solved like slower transfer speeds and the limit on read/write operations. D. Recommendation This paper recommends a BUY for Seagate Technology as its profit picture is bright. However, this is only for the medium term (3-5 years) since flash memory technology will be widely available by then as manufacturing engineering is expected to have solved problems of flash cards such as bringing down its production cost and make it comparable to hard disks. It is understood this recommendation should be subject to a quarterly review by investors if new developments in the industry necessitate a SELL position. This is because the industry it is in is now being “commoditized” and technological changes can render STX very vulnerable. Figure 4: Survey Results among 25 Stock Analysts and their ratings on STX. Source: MSN Money (2011) References Eksin, A. “Microsoft to Spend 90% of its R & D Budget on ‘Cloud’ Technology” 06 Apr. 2011. Web. 07 Apr. 2011 Boogar, S. Directory of IT Systems and Services. Menlo Park, CA, USA: Boogar Lists Publishing, 2011. Print. 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InfoWorld. “News: Big Challenge Ahead for Seagate CEO” InfoWorld Media Group (27 July 1998). Print. San Francisco, CA, USA. International Monetary Fund. “World Economic Outlook: Recovery, Risk and Rebalancing” Oct. 2010. Web. 07 Apr. 2011 Knorr, E. and G. Gruman. “Infoworld: What Cloud Computing Really Means” n.d. Web. 07 Apr. 2011 Merced, de la M. J. “Mergers and Acquisitions: Seagate Ends Leveraged Buyout Talks” The New York Times (Dealbook), 29 Nov. 2010. Web. 06 Apr. 2011 MSN Money. “Seagate Technology (STX): Analyst Ratings” 2011. Web. 07 Apr. 2011 Perdue, W. “Seagate’s View of Cloud Computing’s Impact on Storage” 16 July 2010. Web. 07 Apr. 2011 Pettit, J. “Is a Share Buyback Right for You?” Harvard Business Review 79.40 (Apr. 2001). Print. Boston, MA, USA: Harvard Business School Publishing. Seagate.com “Seagate: Corporate Overview” 2011. Web. 07 Apr. 2011. Read More