A few days ago I wrote reasons why I added more Western Digital shares (stock ticker WDC). After the earnings call yesterday I wrote an article on Gurufocus: Western Digital And Some Thoughts About The Current Market Position. I recommend you to read it if you are interested in the company. I still have some info I would like to add about it to complete my Nth reassessment of the company. I will continue here.

One way to learn about the any industry is to read about it. There is an excellent storage industry newsletter www.storagenewsletter.com with many links storage news, and it’s free. I have learned quite a lot just reading some of the news linked there by receiving emails from them or going to their site. For example you can get news, with comments, about HDD suppliers. Like this article I read today about LSI, a key supplier, that designs, develops and markets storage and networking semiconductors for the HDD/SDD industry.

Interviews are another way to learn about how an industry operates. I have learned things via them that I have not been able to grasp so easily in 10Ks or conference calls. For example even though I have practically read every 10K (and several 10Qs) and conference call of Western Digital and several of Seagate’s since the last 5 years there are small details that I have learned faster, and more entertainingly elsewhere. I remember how much fun I had reading about Seagate’s Bill Watkins (ex CEO). The one (in)famous for saying things like:

“Let’s face it, we’re not changing the world. We’re building a product that helps people buy more crap – and watch porn.”

“The 90s were all about the enterprise, and that’s why Dell did so well. Now, it’s all about the consumer, and that’s why Dell is having problems. They don’t understand the consumer. They want a competitor to the iPod and what do they do? They go with Creative.”

“Apple figured out a long time ago that this business is about the consumer, and the world finally caught up to them. Most companies have a technology and go looking for a problem to solve. Steve Jobs looked at what was happening – people were loading music onto their computers and wanted to take it with them – and he built a product to solve that problem.” (after all, what is an iPod but a hard-drive with a sleek-but-simple operating system and nifty packaging?)

“People worry that newspapers are going out of business. So what? It’s the content that’s important. No one gives a shit about the delivery mechanism. Think about mail. You had the pony express, truck delivery, airmail, email. You don’t care how it gets to you.”

“When you go private, the only thing you think about is going public again.”

“I was at CES, in Vegas. I was supposed to take some meetings, but I said no. I went up to my room, ordered a pizza and watched one of the greatest college football games ever.”

“I lost so much money on that game.” (talking about UT’s 2003 loss in the NCAA basketball Final agains his alma mater Syracuse University)

“The Valley is no longer about building a company and a culture. It’s about making money for the top guys. Intel and Google didn’t think like that, they waited a long time before going public.”

“For a long time, every time a company got to a certain scale, I used to quit and go to a start-up because I didn’t like the bureaucracy. There are no titles. You’re just this group of people with a single-focused endeavor, and I like that feeling, that camaraderie. That’s what got me excited.” (indeed after Seagate he went to Bridgelux, a light emitting diodes company, a start-up)

“You never ask board members what they think. You tell them what you’re going to do.”



I am sure a lot of truth lies in those statements (and that a considerable amount on data is stored in porn :)).

With Western Digital I have had less luck finding instructive interviews, and even though I find it a much better run company I find it’s management quite boring. Fortunately it’s main competitor is much more outspoken about the workings of the industry. I would not trust my money to them but do I use them to learn and invest better with WDC. One great interview that gives insights into the HDD industry is a Forbes magazine interview to Steven Luzco, Seagate’s CEO. Below are interesting questions addressed there and some comments I made.

About consolidation, supply chain and pricing

Q: Steve, this is an industry that has been consolidating for 30 years. A whole bunch of once-public companies are gone, Maxtor, Micropolis, Miniscribe. We’re now down to three, and one of those, Toshiba, is relatively minor. Is this process now done? And if so, do we now see an industry where pricing is more stable? Are the boom-and-bust days over for the drive business?

A: At the drive level you’re done. And you are probably done for the most part throughout the supply chain. As much consolidation that has occurred in drives, upstream it has occurred too. There used to like 9 head companies, and now there’s just one, TDK. In media there were 25 companies, and now there’s 3. Or 2. There has been a lot of consolidation, and the companies that had the strongest technology or the lowest costs have tended to survive, that’s how it is supposed to work.

Q: So will the economics of the business improve?

A: If you look back 5-6 years, there have not actually been a lot of boom and bust cycles other than the macro economy. Supply and demand has been getting more and more in balance, especially as the supply chain has consolidated. You just don’t have as much potential for excess capital as it consolidates. People are more cautious about over-investing. Also, the technology has gotten so much harder -unless you’re vertically integrated, it is really difficult to make next generation products.

Q: And what about pricing?

A: You have a situation where supply and demand probably more often than not is more closely aligned and therefore you don’t have massive under-supplies or massive over-supplies. In the last few years, you’ve either had over-supply because there’s been a shock to the economic system, or under-supply because there’s a shock to the economic system. We had the recession in 2008, where all of a sudden, boom, no one bought drives for four months, so there was this over-supply. But then all of a sudden everybody realized, oh my God, they still needs drives, and everyone had cut back their capital, so there was this huge rebound, and the industry couldn’t respond, so margins went from 15 points to 32 points. And you had the whole European slowdown, which caught the industry and everyone off guard.

Q: But the point is, the drive industry was not the victim of its own bad decision making.

A: Right. It was not so about bad allocation of capital, which is what it was before. The industry has done a pretty good job for the last 4-5 years, and will continue to. But you do have to remember that it is fundamental to our business that you have to keep lowering the price of technology. You have to go from 1.7 billion people using the Internet to 2.5 billion. To get there, chip costs have to come down, drive costs have to come down, bandwidth has to come down. Otherwise you can’t address the developing markets. There’s no doubt that even with three players, it is going to be an aggressive business – but I think some of the volatility gets reduced.



Why total storage volume is what matters, and not HDD unit volumes?

Q: Pre-flood, the market run rate was what?

A: 180 million units. The TAM [total addressable market] is 170-180 million, something like that. 180 is where we were pre-flood, and our estimates then were 180 for December, 180 for March, 180 for June and probably 200 for September. I still think that is probably the right unconstrained TAM. Whether or not September goes to 200 or we get there in December is kind of a function of when does stuff take off for Windows 8, but it is close enough. The most important thing is that the obsession about units is ridiculous.

Q: Why do you say that?

A: Because it isn’t about units, it is about petabytes. For us, however big the shortfall is in units, the shortfall in petabytes is bigger.

Q: Why is that true?

A: Because people are mixing down in order to ship units.

Q: So some of the units have lower capacity.

A: That’s mostly happening on PC drives. If manufacturers are limited on motors, or heads, or disk, then you try to get as many units as you can so customers can sell computers, because you need a disk drive to sell a computer. So if that means I am building a 320 GB drive versus a 500 GB drive, or a 750 GB drive, that is what I’m going to do.

Thailand’s flooding flooding to the supply chain

Q: What’s happening with the drive supply chain?

A: A lot of the critical suppliers are still recovering. Seagate has done a lot of work with our suppliers in terms of assisting them, whether in terms of capital, or clean room access, engineering talent, getting them machines that they need, all sorts of things. When all is said and done, there is probably going to be a reinvestment of at least a couple of billion dollars back into the industry just to get to pre-flood levels.

Hitachi’s acquisition

Q: That’s on top of your production of around 50 million – another 30% or so. The other big deal, meanwhile, is that your chief rival Western Digital bought Hitachi GST. How would you contrast the two deals?

A: Hitachi was a separate company, not an integrated company inside the parent like Samsung. So it was already kind of stand-alone, and much bigger – at least twice as big. They also play in different segments. Hitachi’s stronger in enterprise and notebook; Samsung is really notebook, and channel, so like desktop drives. Samsung’s notebook business was pretty concentrated in terms of customer base, whereas Hitachi’s was broader. But Hitachi was also vertically integrated, with their own head business, and Samsung basically sourced all their technology from TDK and external media guys. So the deals were different on a few levels.

Q: Had you looked at the possibility of buying Hitachi?

A: Not at all. WD needed to do the deal because they needed to get the enterprise business, and they weren’t able to do that on their own, despite trying for 10 years. They are hard products to build, it takes a lot of R&D, the customer set is different, servicing the customer is different, it is really hard. And I’d say the two biggest strengths of Hitachi are their enterprise business and their core technology. They are really good in heads, which is also probably a relative weakness at WD. For us, we have a leading head company and we have the leading enterprise company, so the value for us was different than the value for WD.

Why is the p/e so low?

Q: So, Steve, will that give the Street more respect for what you do? Drive companies historically trade at some of the lowest P/Es in the entire stock market.

A: Investors don’t fundamentally understand what we do. They tend to think, if things are bad, that’s how they’re going to stay, and if things are good, they’re going to get bad. That’s really been the philosophy. The glass is either half-empty, or its empty. Do I think that’s going to change? I don’t know. There are other big successful technology companies where you scratch your head and say why are they trading at an 8 P/E. Why is Microsoft trading at an 8 P/E? Why is Intel trading at an 8 P/E? I think a lot of it is a different discussion entirely, which is do our capital markets fairly value companies anymore fundamentally, and I’ll tell you my answer is no.

Q: Why not?

A: Because they’re not being priced on fundamentals, they’re being priced by the large investment banks for volume. And volume requires volatility. So that’s why all the big firms are in a different camp than the smaller research firms on their perspective of the drive industry. Is it because these are the smart guys, and those aren’t? That doesn’t make any sense. It is because the big banks are motivated by volatility and the boutique firms aren’t. And therefore the research reflects that. So you can create an environment that always creates doubt, with billion dollar market cap swings in a week. It’s insane. Why does that work? Because you have traders who love to make that work. So do I think that changes? I don’t know that I see that changing for our equity markets in general, which is a terrible thing for the efficient allocation of capital. Does it change at the margin for the drive industry, if there is less volatility? Sure, I think it does. It takes time though. It’s going to take time.



Those last two answers are interesting. Luzco says that companies are not priced on fundamentals. He gives examples of two solid companies like Intel and Microsoft which are cheaply valued. So cheap that it does not make sense on a fundamental basis. The reason is that big banks want volatility because their trader customers want it. So they produce research reports that generate an environment of doubt to create volatility because traders like it. Basically he says that the market is not efficient but manipulated. Manipulated by big banks via the research reports they produce so that traders are pleased. Why could that be? Maybe because traders then earn money and banks take a percentage of it. So basically they operate together. Who loses? Probably the retail investor. He also says that small research firms are not into that game. Even if they wanted they could not generate big price changes because they cannot influence the market due to their lack of reach. The small market research firms therefore produce better, fundamentally focused, research reports.

It’s an interesting opinion, I never heard it before explained like that. I do not know what the truth is or if the market is more or less efficient than before. Thinking about my personal gains I would prefer that being true. If the HDD companies, or any company for that matter, are mispriced there are opportunities to profit from it. If it was perfectly efficient I would not have this “job”, I would not be investing.

About SSDs or the flash industry



Q: Let’s talk about the impact of flash memory on the drive industry.

A: Any analyst who is worrying about that fundamentally doesn’t understand the industry. Flash is a complimentary technology, it’s not a competitive technology.

That’s an interesting answer, he says flash is not even worth worrying about. Supposing that is true, by logical consequence if you extremely worry, like if you think that the SSD is the death of the HDD, you do not understand the industry. It does not replace HDDs in the storage ecosystem, it complements them. That means that there is place for both. I think to some level it will substitute HDDs and enable having less total storage than would be needed if they did not exist. So if flash memory did not exist, storage needs would be higher. SSDs allow having less total storage, by having a more efficient data distribution, but in no way eliminate HHDs. For the reason why I think that you can see the last three paragraphs on the gurufocus article.

SSDs store some data, but most of it is stored in HDDs, that still happens even if everyone uses SSDs. Data does not disappear because SSDs are used, it ends up in some HDD anyways.

Why Many ultrabooks will come with hybrid drives ?

Most of the data will keep on being stored in an HDD in 4 years from now, even with all consumers using SSDs



Q: Intel is out pushing ultrabooks with all their might. Some have drives, and some of which don’t.

A: If you want to store anything on it, it will have a drive, or you are going to pay a lot of money for flash. I mean, yeah, if a bunch of rich people in Atherton want to buy a PC for $1,000 that has 128 gigs, then, sure. I just don’t think that is much of the world, and oh by the way, if they have that machine, they have some other machine somewhere that’s got 5 terabytes on it, because I can’t do much with 128 gigs. So those products that are built for speed and mobility, those still need support of mass storage somewhere. And oh by the way, most ultrabooks, or thin and light, which is a different term – ultrabook is an Intel marketing term, so hopefully you’ve received your check this week for using that term – those have certain requirements on performance, and certain budgets on price. And the right answer for that is probably going to be a hybrid drive, because that is the only thing that can get you the performance they’re asking for at the budget they’re asking for if you want any amount of storage capacity.

Q: What about the idea that tablets have begun to cannibalize laptop sales?

A: Maybe they have. But then they’ve driven storage sales somewhere else. If it’s an Internet access device, which is what I think it is, then people are using it to watch YouTube and share videos. So where is all that stuff?

Q: Sitting someplace on a drive. So, demand for drive capacity will continue to grow.

A: Our industry shipped 100 exabytes of data five years ago, 400 exabytes in 2011, and we’ll probably ship a zettabyte sometime between 2015 and 2016. A zettabyte is equal to all the data that’s been digitized from 1957 through 2010. Everything, however you want to think of it, cards, tapes, PCs, mainframes, client/server, minicomputers – one zettabyte. And we’re going to ship that in one year. So whatever the architecture is, pads, phones, notebooks, ultrabooks, real notebooks, PCs, servers, clouds, one year, a zettabyte – that’s all going to be on rotating mass storage.



That’s a good point, even if tablets with SSDs replace notebooks with HDDs most of the data is still stored in an HDD. Storage amount is increasing a lot and storage sales are not affected since most of the data ends up stored on HHDs independent of if an SSD is used or not. There is no need to worry if sales of notebooks with HDDs are decreasing. No need to worry if sales of tablets with SSDs are increasing, it is actually happening. Even if everyone uses SSDs, most of the data will still be stored somewhere in an HDD. Storage demand is here to stay and grows enormously. As long as the gigabytes in HDDs are less expensive than the gigabites in SSDs HDDs will be used to store.

Current SSD capacity SSD can satisfy only an insignificant amount of storage demand. Even if everyone wanted to use SSD’s, investments of 500 billions in new capacity would only scratch the surface to satisfy storage needs

Q: And demand will keep ratcheting up from there.

A: By 2020, that number is somewhere between 7 and 35 zettabytes, depending on who you’re talking to – Seagate, which says 7, or EMC, which says 35. There is no amount of flash that can even address one tenth of one percent of that. People get locked in to this view at a device level. Yes, you could have some number of units that are serviced by flash. Let’s hope so. In fact, my bigger concern is that the flash guys can’t figure out how to keep delivering the performance and costs that they’ve been able to as they get to sub-21 nanometers, than it is that somehow they’re going to replace HDDs. Not without literally $500 billion of investment in fabs they’re not. And even then they’d only be scraping the surface.

Cheers!

jrv

PD: this post has not been finished I will add some more information, once finished this message will be removed