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Storage Kings

Alvin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Seagate Technology (NASDAQ: STX) and Western Digital (NASDAQ: WDC) dominate the hard disk drive (HDD) market. In Q2 2012, the two companies combined for 87% of the market. The other 13% was owned by Toshiba. The HDD market has been recovering from last year’s devastating Thailand floods, which temporarily knocked Western Digital from its top spot. Thailand has 25% of the total HDD assembly facilities in the world (iSuppli).

The following table shows HDD shipments from Q2 2011 to Q2 2012 (iSuppli).

<table> <tbody> <tr> <td>Shipment Units (millions)</td> <td>Q2 2012</td> <td>Q1 2012</td> <td>Q4 2011</td> <td>Q3 2011</td> <td>Q2 2011</td> </tr> <tr> <td>Western Digital</td> <td>71</td> <td>63.8</td> <td>28.5</td> <td>57.8</td> <td>53.8</td> </tr> <tr> <td>Seagate</td> <td>65.9</td> <td>60.7</td> <td>46.9</td> <td>50.8</td> <td>52.25</td> </tr> <tr> <td>Toshiba</td> <td>20.1</td> <td>20.6</td> <td>19.3</td> <td>22.2</td> <td>17.747</td> </tr> <tr> <td><strong>Hitachi</strong> GST</td> <td>-</td> <td>-</td> <td>17.2</td> <td>31.9</td> <td>26.9</td> </tr> <tr> <td><strong>Samsung</strong></td> <td>-</td> <td>-</td> <td>11.3</td> <td>12.5</td> <td>16.15</td> </tr> <tr> <td>Total</td> <td>157</td> <td>145.1</td> <td>123.3</td> <td>175.2</td> <td>166.847</td> </tr> </tbody> </table>

As shown, the HDD market bottomed in Q4 and is still recovering. In addition to the flooding, the HDD market has experienced consolidation. Western Digital bought rival Hitachi GST for $4.8 billion and Seagate bought Samsung’s HDD business for $1.4 billion. This effectively turns the HDD market into a duopoly with Toshiba picking up a relatively small market share as the third company. Besides lowering costs, the benefits to Western Digital and Seagate are entry into the enterprise market and a partnership with Samsung, respectively. Samsung will supply Seagate with semiconductor products and Seagate will supply Samsung with HDDs (Seagate).

Looking forward, the HDD market faces rising demand due to the rapid advancement of technology. For example, the use of public cloud storage, which requires servers with huge amounts of storage capacity, is on the rise. The online streaming of movies, TV shows, personal videos, and music are also driving demand. In addition, applications and personal data now easily take up gigabytes of memory. Basically, the world is hungry for storage capacity. According to iSuppli, HDD shipments are projected to climb from the 502.5 million units shipped in 2011 to 575.1 million units in 2016. The forecast does not include external hard drives.

Western Digital states, in its 2012 Annual Report, “Storage continues to be critical to the mass of digital content being created and utilized...We believe the volume of petabytes stored will grow by about one-third annually to calendar year 2016. That growth, and the need to periodically refresh consumer and commercial information systems, gives us great encouragement about the future of the hard drive industry.”

However, solid state drives (SSDs) are a threat to HDD manufacturers. SSDs perform the same function as HDDs, but they have no moving parts and are significantly faster (read and write speeds and access time) than HDDs. Also, SSDs use less power. Basically, SSDs are superior to HDDs. However, they are significantly more expensive, around 10 times more expensive than HDDs in terms of cost per gigabyte. Additionally, SSD capacities are significantly lower than HDDs. For example, on newegg.com, there are only two SSDs with a capacity of 1TB and both are from OCZ Technology. On the other hand, there are 47 1TB HDDs and 40 2TB HDDs listed from multiple companies.

The SSD market contains many competitors. Intel, SanDisk, STEC, Samsung, and OCZ are some of the biggest competitors. The most influential are probably Intel, SanDisk, and Samsung because they have their own foundries and established reputations. However, Western Digital and Seagate are not (yet) in trouble because in Q1 of year 2012 only 3% of the total global shipment of notebook PCs solely used SSDs. Also, cheap storage is extremely important because of the huge rising amounts of data people need to store. Additionally, Western Digital and Seagate have SSD products and have hybrid drives (note: Western Digital is working on a hybrid). Hybrid drives are HDDs that use NAND memory as a cache. Basically, a hybrid provides some SSD type performance while providing the large amount of capacity available with HDDs. Also, hybrid drives are cheaper than SSDs. These factors provide protection for both companies and investors.

Overall, Western Digital and Seagate make good long-term investments. It is hard to pick a winner between the two because they are locked closely in the battle for dominance with Western Digital slightly ahead. However, Western Digital has been more consistent and has a lower price to tangible book value ratio of 1.8. Seagate has a price to tangible book value of 4.4. The slightly larger market share, more consistent performance, and the cheaper ratio make Western Digital the better investment. It should be noted that the PE ratios for both companies are not good metrics to use because they are artificially deflated due to shortages cost by the flood in Thailand. Regardless, both companies are good.

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Alvin owns shares of Intel. The Motley Fool owns shares of Intel and Western Digital. Motley Fool newsletter services recommend Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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