Seagate announced yesterday that they were in preliminary talks to go private again. This isn’t the first time around the block for Seagate, or Steve Luczo.
On March 29, 2000, Seagate announced a complex deal that would take the company private, while divesting some of it’s non-core assets. The deal was valued at $19 billion, even though Silver Lake, TPG, and the Seagate executives purchased the hard disk drive business for ~$2 billion. A little more than two years later, on December 11, 2002, 17% of Seagate was offered in an IPO, valuing the shares a $12/each, and the company at $5.2 billion. A $3.2 billion profit in just over two years. Not bad at all…
I note the analysts’ roundup below, but I believe they are missing a big part of why Seagate might do better as a private company. However, even if Seagate goes private, one must ask what value the company’s stock is missing right now.
Public companies don’t typically have the stomach for tough moves and tough decisions that require large amounts of up-front investment to pivot their primary business model. Whereas the total storage market continues to grow at a extraordinary pace worldwide, magnetic hard disk drive technology is increasingly facing new challenges from other technologies. Seagate, and other HDD manufacturers, have benefited from the fact that a large number of consumer devices worldwide have required hard drives as a basic component in order to run a computer. The advent of the internet and emerging markets (third world) only increased the demand for personal computers. However, the advent of solid-state memory is becoming a strong competitor, and when you take a long-term view, a viable alternative to the spinning hard disk.
When Seagate originally went private, the company had interests in many different areas, such as Veritas, that were not a part of it’s core HDD business. The Seagate of today is largely HDD focused, and even its divisions, such as i365, are built around selling and maintaining HDDs. Thus, long-term, Seagate is at risk for being in a declining market. By taking the company private, Steve Luczo could change Seagate’s strategic direction and make outsized short-term investments that would have long-term benefits. While still a public company, the stock could take a beating, but if the company was private, it would largely maintain it’s value.
Possible Moves for Seagate
- Solid-State — Seagate already has announced a partnership with Samsung to bring an enterprise-class SSD to market, but this isn’t enough to gain a significant share of the solid-state storage market and make up for a large loss in the consumer segment. Seagate could undertake a much larger R&D position on solid-state, possibly buying another manufacturer (Enterprise: STEC?/Consumer: OCZ?) or merging with a larger memory manufacturer.
- Enterprise Storage — Seagate could add significant value from the experience they have had with partners (EMC, HP) in creating a truly vertically integrated storage company. Think of a Seagate merging or competing with an EMC or like company. Seagate has taken advantage of the benefits of having a vertically integrated supply chain, and while this would change the company dramatically, it should yield higher profits.
- Prepare for M&A sale — Would a HP, EMC, or like company want to purchase the source of a large portion of their cost? HDDs are quite expensive when you look at the overall cost of computing systems. It may make sense to hold it as a fully owned subsidiary.
- Samsung Buyout of Seagate — The rumor mill is claiming that Samsung is also a possible suitor for Seagate, but I don’t buy it. Samsung has had a hard drive division for years, which has always had a steady market share. They rely on partners for a variety of the components to make HDDs, and are not vertically integrated. That said, Samsung has a complete line-up of desktop and notebook drives, with enterprise technology that could be deployed, but they opted to focus on SSDs in the enterprise space. So, why buy Seagate? The only reason could be to gain the #1 spot in hard drive manufacturing volume. To me, that just doesn’t make sense.
- Streamlined Operations — Back in 2000, Seagate was trading largely based on the value of Veritas, and not as a traditional hard drive company. This presented an opportunity to take it private, streamline operations, and repackage it on the market as something completely different than what is was trading for in 2000. Today, Seagate is a streamlined, vertically-integrated manufacturer of HDDs. Even if some of the possible “moves” I mentioned come true, the stock should largely be trading at the same values (unless SSDs or Enterprise Storage become wildly more profitable in the next three years; see SanDisk). There just simply isn’t a lot of fat to cut, and nothing to transform the company into.
- Stock Valuation — Just a few weeks ago, Seagate was trading as low as $9.84, but as soon as the possible buyout was announced, the stock went up to the mid-$15 range. What was appealing at $10.50 may not be as appealing at $15, a full 30% premium.
- Seagate Execs Playing the News — Anyone think that possibly Seagate knew that they would show weak profit and revenue results for Q3, but wanted something to keep investors and analysts at bay? Rather than focus on the core business in the past few weeks, all eyes have been on the buyout discussions. Even during Seagate’s quarterly conference call, the analysts were constantly trying to get Seagate to talk about any sort of future projection, but Seagate employed a lawyer to “prevent” them from saying anything due to the possible buyout.
Of course, these are just my notes from the outside… Here’s what the professional analysts have to say:
Analyst Commentary (from Barron’s)
- Richard Kugele, Needham: He boosts his target on the stock to $20, from $15. “Based on our industry discussions and knowledge of STX, we do not believe any transaction would occur below 7x EV/normalized cash flow,” suggesting a price of $18-$20.
- Kaushik Roy, Wedbush: Roy maintains his Neutral rating and $17 target. Roy says a bid for STX is not surprising considering they have lately been trading at close to 6x forward earnings. But he also notes that there isn’t a lot of fat in the company to squeeze out; he says CEO Steve Luczo has the company running at a “high level of operational efficiency,” and he thinks that rivals Western Digital and Hitachi likewise are being well run. “There isn’t anything significant private equity can do from an operational or strategic standpoint, in our opinion,” he writes. Roy also notes that the stocks have been depressed on near-term weakness in PC demand, as well as aggressive pricing that has hurt margins and profits. A wild card for the industry has been the cannibalization of notebooks by tablets, which hurts drive sales. That said, he thinks shorts should cover here.
- Mark Moskowitz, J.P. Morgan: He keeps his $15 target, and writes that a take-out likely won’t be at a price much higher than his target, given “current secular trends and risks.:”
- Ben Reitzes, Barclays Capital: “Assuming the private equity firms require a mid-to-high teens IRR, and using very cautious EBITDA and revenue assumptions, we can value Seagate in the range of $16 a share, which is close to the after-market price” yesterday.
- Arun Sharma, UBS: “We believe private equity willingness to pursue a deal highlights the unrecognized value and overly negative sentiment still reflected in shares,” he writes. “While we still have some questions around the rationale of an LBO, as weakness in shares has been more macro/industry related rather than company specific, our checks indicate that the likelihood of a deal is increasing and expect further details on progress in the coming weeks.” He keeps his $15 target.
- Jayson Noland, Baird: “We expect near-term upside to the stock followed by volatility given uncertainty around price, timing and likelihood of a transaction. We would not expect much more than $15 or $16 per share for STX off current levels.”
- Rajesh Ghai, ThinkEquity: “While we believe shareholders, STX’s management, and private equity investors are likely to be very favorably inclined toward the deal, we fear the group unlikely to be convinced easily could be debt financiers of the proposed LBO,” he writes. “While the post-LBO capital structure is not clear at this point of time, we estimate at least $7 billion of the deal will have to be funded through fresh debt. Debt-holder concerns are likely to center around the riskiness of STX’s [free cash flow]…We recommend investors take some chips off the table on near-term strength in the stock emanating from the deal announcement.”
- Amit Daryanani, RBC Capital: He still has a Sector Perform rating and $13 target. He notes that there have been four comparable deals over the last decade: the Silver Lake $2 billion acquisition of Seagate in March 2000 for about 0.3x EV/trailing 12 months revenue; Seagate’s acquisition of Maxtor in 2005 at 0.5x; Western Digital’s purchase of Hoya’s media sputtering operations this past April at 0.9x; and Western’s acquisition of Komag in 2007 at 0.9x. At Thursday’s close, he notes, STX was trading at 0.5x.
- Sherri Scribner, Deutsche Bank: “At the time of the [previous LBO] deal, Seagate had a number of non-HDD related businesses, including shares in Veritas, which were sold off to help repay debt,” she notes. “Today, STX is a leaner company, without any non-core HDD assets to sell. However, the HDD industry has consolidated and despite recent declines, the industry is more profitable than in the past.” She notes that STX had $190 million in free cash flow in FY 2009, at the height of the recession, despite a 23% drop in revenue. In FY 2010, the company had $1.3 billion in free cash flow. “We
believe this ability to generate cash in the worst of times could be attractive to private equity firms.”
- William Fearnley, Janney Capital: He’s sticking to his Neutral rating and $12 target for now. Fearnley thinks the most attractive part of the company is its enterprise business, which is about 35% of revenues.
- Shebly Seyrafi, Capstone Investments: He keeps his Hold rating, while boosting his target to $14, from $12, “to reflect increased odds that the company be acquired and to reflect a notable pickup in PC sales at the end of September.”