1 Stock To Buy Amidst Disruptive Tech Innovation, 1 To Avoid

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

Although data growth has been strong, supply chain disruptions, a weak macro environment, and increased competition have become major headwinds for computer storage producers. In many cases, multiples have sunk so low that investors are now asking themselves "why not". Don't fall for value traps. Make sure to hunt out the low multiple stocks that are complemented with strong balance sheets and excellent momentum. This will at least help you limit the downside should the industry at large prove to be a value trap.

Western Digital's (NASDAQ: WDC) Cash Story Makes It An Ideal Target

At around 4.6x forward earnings despite strong free cash flow generation, Western Digital appears to be exceptionally beaten down after its high at $45 around mid-August this year. EPS has been consistently above expectations by an average of 32.6% over the last few quarters, although it was only nominally higher (2.2%) at $2.36 in 1Q13.

During the first quarter, management incurred $26 million in expenses to help production better meet future demand. Free cash flow came out to $554 million for just the quarter, which, if you consider the business is worth $8.4 billion, indicates a substantial value discount. Cash now total $3.2 billion versus $2 billion for debt. These reasons make Western Digital a possible takeover target for a peer firm, like EMC Corporation (NYSE: EMC). EMC has $6.4 billion in cash, so it can easily initiate a takeover by using what it has on hand plus any needed leverage that is secured against Western Digital's own assets.

EMC has already been in takeover mode of late. Just yesterday, the company announced that it would purchase Silver Tail for an undisclosed amount. This acquisition will provide EMC with a large control on corporate network data to better identify hackers. Buying out Western Digital would help EMC gain a more sustainable control of hard drives and markets supporting audio and video use. In addition, it would also connect the company to greater momentum. For the December quarter, Western Digital has guided for upwards of $3.7 billion in revenue despite a muted business environment. Cannibalization from tablets and smartphones may be a major headwind, but the long-term growth rate in HDD is still solid at 3%.

Avoid Seagate Technology (NASDAQ: STX)

In contrast to Western Digital, Seagate performed weakly in the first quarter. The stock fell 3.1% after the company missed expectations by $0.25 on EPS of $1.45 despite repurchasing $670 million worth of shares. Moreover, management guided for $3.5 billion in revenue for the second quarter - a figure that is $400 million below the original target. Analysts now rate the stock around a "sell" with a respective PE and forward PE multiple of 4.3x and 4.4x.

Despite operational weakness, at the recent earnings call, management said that "first quarter results reflect strong operational performance as the company responded quickly to demand and product mix shifts in a challenging environment".  The company then followed by mentioning sluggish macro growth, weak spending amidst debt crises, and supply chain weakness for OEMs, among other factors. Furthermore, management gave a weak outlook on emerging markets--estimating that China won't recover to normalized growth rates until late spring 2013.

At the same time, the company has said that it will aim to spend more this December quarter than usual following the takeover of LaCie. While global Internet connectivity and data use continue to grow at robust rates, open source software and cloud infrastructure is moving fast and making it hard for Seagate to keep up.

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TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of EMC and 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.If you have questions about this post or the Fool’s blog network, click here for information.

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