Technology

A New Wave Lifts Battered Seagate


By Sarah Lacy Seagate Technology (STX) has been scrambling the past few months to recover from a misjudgment in late 2003 that ultimately threatened to take down the whole industry.

Eighteen months ago, the biggest maker of hard drives for servers and computers was so convinced PC sales would continue soaring that it flooded the market with its products. But the market didn't rebound as expected, so Seagate and rivals ended up slashing prices to unload inventory. By the middle of last year, many of the stocks were trading at lows not seen since 2002.

The damage from that misstep is fading quickly, though, as Seagate and competitors get a boost from everyone's favorite music-player-turned-fashion-accessory -- the iPod. Not content to just make hip urbanites and college kids look cool, Apple's (AAPL) device is rejuvenating the disk-drive industry, with Seagate benefiting in particular.

IMPRESSIVE RAMP-UP. Last June, Seagate announced its first products for the consumer electronics market, including a 1-inch drive being used in some iPod Minis as well as competing devices by Rio, Creative, and others. By the end of the year, Seagate was shipping 23% of the market's 1-inch drives. The company was edged out by only Hitachi (HIT), its most formidable rival in this realm, according to IDC, a research firm in Framingham, Mass.

With 1.5 million units shipped, it was the fastest ramp-up a Seagate product has seen, says Pat O'Malley, senior vice-president of consumer electronics for the company. Seagate unveiled a 6-gigabyte version in late February, in lockstep with Hitachi. "It's a fun time for us," he says. "We're cool again."

The iPod's success symbolizes a new world of consumer electronics, where phones, PDAs, music players, and video players converge to form superdevices that need powerful memories. Add to that the digital living room aspirations of companies like TiVo (TIVO), Microsoft (MSFT), and the PC makers, where a family's pictures, movies, and music are all on one device. It could mean far more drives than have ever been sold before.

GOOD TIMING. Just a few years ago, most households probably had one disk drive, as part of their computer -- maybe two, if they had a laptop. Now, they've got drives in MP3 players, TiVos, X-boxes, and soon -- the hope is -- cell phones. A typical household could have as many as 10 or 20 hard drives.

Seagate and its rivals are calling it the fourth wave for their industry, comparable to selling drives for hulking mainframes, minicomputers, and, more recently, PCs. Seagate may have jumped in just in time. In six months, it has almost overtaken Hitachi, which has made a 1-inch drive since 1999. Competitor Maxtor (MXO) has been slower to the market, with its small drives a year out. Consumer electronics concerns like Fujitsu and Samsung (SAMCF) are just now talking about taking the plunge.

The consumer electronics vision isn't new for drivemakers, but the iPod and, to a lesser extent, Microsoft's X-Box and TiVo-like devices are finally making it a reality, says Dave Reinsel, IDC's director of storage research. In 2003, 20 million drives were sold to consumer electronics outfits. In 2004, that figure more than doubled, to 43 million drives. By 2008, IDC expects that the industry will be buying 165 million drives -- more than 30% of drivemakers' total output.

PERSISTENT CHALLENGES. The trend has played a big role in jumpstarting the revenues of Seagate and its brethren. In 2003, the initial year unit volumes were significant, revenues for the disk-drive industry grew for the first time since 1997. Sales rose again last year, and IDC predicts another up year in 2005, with revenues reaching $25 million. One more year of outperformance could eclipse the industry's peak sales of $27 billion in 1997. Margins on these drives are also fatter than on traditional products, execs say.

It's all good news for Seagate, whose stock is trading at $17.68, near its 52-week high of $18.39. It has even been upgraded by some of the same analysts who downgraded the stock less than a year ago.

To be sure, staying on top will be tough. For one, there are the same issues that have always plagued the drivemakers: Stiff competition and severe pricing pressure. The downward squeeze on prices may be worse with consumer electronics, as the mass market wants more and more functionality for $199 or less, Reinsel says.

LOOKING LIKE A LEMUR. Then there are the new challenges unique to the consumer electronics market that outfits like Seagate have never encountered. Some are technical. Thanks to Microsoft and Intel (INTC), PCs share common standards that consumer electronics don't. That means Seagate will have to make many more flavors of drives than it has in the past. And being part of mobile products not only pushes the boundaries of how small drives can get but also requires more shock resistance, heat resistance, and, potentially, even water resistance.

On the sales and marketing front, Seagate needs to forge relationships with all the consumer electronics companies it hasn't dealt with before. And that includes more small and midsize businesses than it has worked with before.

Demand is another wild card. It's very hard to forecast what device will take off. Before the iPod, MP3 players were a sleepy market. That means a big potential for miscues like Seagate's 2003 mistake: Overproducing for a market that never materializes. "The whole application thing is moving pretty fast," O'Malley says. "We've never before had to deal with so many applications and so many architectures. We have to look like the lemur with huge eyeballs and huge ears and very thin lips."

UNCEASING COMPETITION. These variables may give competitors like Hitachi and Samsung a leg up. While Seagate's ability to focus solely on drives is an advantage, Hitachi and Samsung have deep roots in consumer electronics. They already know how the business works, IDC's Reinsel says. Seagate is "catching up, but they're still learning," says Bill Healy, senior vice-president of product strategy and marketing for Hitachi.

For now, Seagate is riding the consumer electronics wave, and there's more than enough business to go around. But as growth tails off and competition grows, the real test will be avoiding the cut-throat price wars that have ruined profits for disk drives in every other market. And competitors can only hope Seagate doesn't repeat the past mistake of flooding the market and causing a wipeout for everyone. Lacy is a writer for BusinessWeek Online in New York


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