Two Tech Stalwarts Changing With The Times
Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Western Digital (NASDAQ: WDC) controls around 40% of the hard drive market. That's a slowly dying business as new technology displaces the need for storage with moving parts. Western Digital is doing something about this problem and so is its main competitor.
Hard drives provide the best combination of storage space and cost. If the chip is the brains of a computer, the hard drive is the heart. Although the technology in a hard drive is amazing, it involves a spinning disk. That results in two negatives, the drives are relatively fragile and it takes time for them to get information to users.
A new form of storage, solid state drives, solve both problems. What such drives aren't, however, is cheap. That's an important distinction and one that keeps the old fashioned hard drive in a dominant position in PC land.
New devices like tablet computers and cell phones, though, don't use hard drives. As these devices have grown in popularity, they have begun to displace personal computers. That's had a chilling effect on hard drive demand.
Seeing the writing on the wall, however, Western Digital has been taking steps to mitigate the issue. The first was aggressive acquisitions of hard drive makers. This cemented the company's position in the industry. That's the same push that Seagate Technology (NASDAQ: STX) has made. Together they control around 80% of the market.
That's created dominant cash cow businesses that each has used to grow in new markets. That said, the pair have traveled slightly different paths. Western Digital has used its cash to clean up its balance sheet and Seagate has been returning value to shareholders through stock buybacks and a larger dividend.
At the end of the first quarter, debt made up under 20% of Western Digital's capital structure despite a large hard drive acquisition in early 2012. In fact, the company has already paid off $200 million of the $2 billion in debt it had in the first quarter of last year. Debt at Seagate makes up just over 40% of its capital structure.
That said, Seagate shares yield around 3.3% while Western Digital's shares yield about 1.6%. Clearly, income investors should favor Seagate. Those seeking growth, on the other hand, should be looking to Western Digital.
With less debt and a more aggressive stance on keeping its balance sheet clean, Western Digital has been able to gain scale quickly. Seagate's top line has a little more than doubled over the last decade, going from about $6.5 billion to $14.9 billion. Western Digital, meanwhile, has increased its top line almost five fold, taking it from $2.7 billion to $12.5 billion.
Western Digital's most recent acquisition is the opportunistic purchase of money losing solid state drive maker Stec (NASDAQ: STEC). It's a $340 million all cash deal that placed a 90% premium on Stec's valuation the day before the deal. The solid state drive maker's shares obviously rocketed higher on the news. The company only brought in around $170 million in revenue in 2012, posting a loss of $2.22 a share. That's not a particularly good business, but one that Western Digital was able to buy on the cheap to bolster its position in the solid state drive market.
Stec's top line and earnings were $305 million and $0.50 a share, respectively, in 2011. So the business suffered greatly in 2012. Stec shareholders should probably sell the shares to lock in the price gain. If the deal falls apart, the shares will fall hard since Stec's business is struggling.
Not Dead Yet
While expansion like this is important, investors also need to keep in mind that hard drives are likely to have a long life ahead of them. That's true because mobile devices are connecting to computers that use hard disk drives. The more mobile devices, the more need for computers and cheap storage. Moreover, emerging markets are starting to make greater use of technology and cheap is the preferred option. That means hard drives.
Two Options, Similar Paths
Western Digital is a growth oriented investment option, with management doing an impressive job of keeping the balance sheet clean and, at the same time, expanding the business. Seagate has been more focused on returning value to shareholders and, thus, has a notably higher yield and about twice as much debt. It's a better option for income investors. Both, however, are working on shifting into the solid state drive market and likely have plenty of time to make the transition. The choice, then, is how you want to get there.
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Reuben Brewer has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!