Price Wars Hit Seagate

The leading disk drive maker sees a shortfall in revenue for the March quarter as product prices dropped

Seagate Technology (STX) warned that its revenue would be lower than expected for the March quarter, as the hard disk drive maker continues to struggle against rivals in a bitter price war that has lasted for years. After the news, the stock fell 9% to $21.34 in late morning trading on the New York Stock Exchange Apr. 10.

The Scotts Valley (Calif.) company said late Apr. 9 that its revenue for the fiscal third quarter will be around $2.8 billion, compared to prior guidance of $2.9 billion to $3.0 billion. Profit margins did not achieve the company's expectations, either. Analysts surveyed by Thomson Financial had been expecting the company to earn 58 cents per share on $2.9 billion revenue.

Seagate blamed its shortfall, which became evident toward the end of March, on more aggressive than expected prices on products known as high capacity 3.5-inch ATA disc drives. Also, the industry didn't show as much demand as hoped for 3.5-inch ATA disc drives, the company says.

"Pricing pressures will bring down some of their near term profitability, but as a whole the company is still in a strong position," Morningstar analyst Andrew Golomb says. He had already been expecting such competition to eat into Seagate's growth and had a fair value estimate of $22 on the stock in January.

Seagate has been embroiled in a price war with rivals like Hitachi and Toshiba for years. The tempo picked up after Seagate agreed to buy the hard disk drive maker Maxtor Corp. for around $1.9 billion in December, 2005. The deal prompted rivals to try to persuade Seagate customers, who typically prefer to buy from more than one supplier, to broaden their business beyond Maxtor and Seagate.

But Seagate continues to try to stay ahead of the curve by inventing new strategies. For example, the company announced a new family of products in January called FreeAgent that it will sell directly to consumers as a way to ensure that the pictures, music, and other digitally stored pieces of their lives don't disappear in a blink of an eye. Most of the company's customers have been computer and consumer electronics makers that need to put hard drives into the products they sell - but large commercial customers in the technology world can play hardball on price negotiations (see BusinessWeek.com, 1/15/07, "Can Seagate Make Disk Drives Sexy?").

While Seagate has been battling for such customers lately against rivals that are willing to notch prices lower, the company still believes that its market share is virtually unchanged from the previous quarter. In 2006, Seagate was the leading provider of hard drives, with a market share position of 29%, according to Standard & Poor's Equity Research (S&P, like BusinessWeek.com, is owned by The McGraw-Hill Companies). This is well ahead of its nearest competitor, Western Digital (WDC), which had 18% of the market.

And Seagate insists business is still healthy. "Overall, the company's results continue to be healthy and are reflective of its leadership position in an industry where consumers and applications are using, creating and sharing digital content at an accelerating pace," the company said in its Apr. 9 statement.

One analyst downgraded the stock after the company's revenue warning. Needham analyst Richard Kugele lowered his recommendation to buy from strong buy, saying he sees gross margin below the company's prior 24%-24.5% guidance; thus he thinks its EPS shortfall could be up to 10 cents per share relative to the midpoint of prior 50-60 cents per share guidance (including options). In a research note, he says he believes the end-of-quarter channel slowdown was due to chip inventory and processor price cuts, as well as aggressive mobile pricing that caused players to seek margin elsewhere and led to price pressure.

Kugele lowered his $1.91 fiscal year 2007 (June) EPS estimate to $1.64, and $2.84 for fiscal year 2008 to $2.42. As for the stock, he thinks its historical trough valuation limits further downside, and sees leverage potential in model. He has a $25 price target on the stock.

Other analysts saw a buying opportunity. "We view the stock as undervalued and would buy the shares," Standard & Poor's Equity Research analysts Jay Hingorani and Jim Yin said in a research note Apr. 10, even as they lowered their expectations of Seagate's earnings for the fiscal year ended June to $1.43 from $1.75 and a 12-month target price on the stock to $29 from $32.