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What Wall Street Wants Can HDDs Ever Be “Investments” or Only “Trading” Stocks?

What Wall Street Wants Can HDDs Ever Be “Investments” or Only “Trading” Stocks?. Needs. Rob Cihra Hardware Analyst, Managing Director Fulcrum Global Partners LLC September 2004. My Bio.

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What Wall Street Wants Can HDDs Ever Be “Investments” or Only “Trading” Stocks?

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  1. What Wall Street WantsCan HDDs Ever Be “Investments” or Only “Trading” Stocks? Needs Rob Cihra Hardware Analyst, Managing Director Fulcrum Global Partners LLC September 2004 1

  2. My Bio • Senior research analyst covering Computer Systems/Storage markets for past 7 years (previously w/ ABN AMRO, ING Barings) • Fulcrum a 3yr old NY-based institutional research-driven securities firm w/ 30 analysts 2

  3. Wall Street’s Driven By: • IN-DEPTH FUNDAMENTAL ANALYSIS • Investment thesis • Competitive positioning • New product developments/technologies • Valuation • EMOTION • Greed • Fear  Wall Street wants PROFITS, GROWTH and CONSISTENCY…and will REWARD them 3

  4. Investors Seek Out Returns on Their Capital 4

  5. Now for the HDD Sector 5

  6. Relative 13-Year Stock Performance: Logarithmic Scale to be “Kind”(DELL, EMC, S&P vs. MXO, STX, WDC) HDD stocks relatively under-perform 6 Source: Fulcrum Global Partners.

  7. Relative 13-Year Stock Performance: Actual Scale to be “Realistic”(DELL, EMC, S&P vs. MXO, STX, WDC) Compare the current values of $1 invested in 1991 Compare the current values of $1 invested in 1991 Compare the current values of $1 invested in 1991 Compare the current values of $1 invested in 1991 7 Source: Fulcrum Global Partners.

  8. HDDs as Stocks • As products/techs, HDDs have been a phenomenal success • As stocks, they’ve been a long-term disappointment • Vicious cycle of boom/bust • Rapid commoditization, Irrational competition • Since 1995, cumulative Sales of STX+MXO+WDC = $116 billion but Profits just $322 million or 0.3% • Today  Investor disbelief/distrust • Even if macro environment changed can the companies change too? • Can HDDs ever be “investments” or are they simply “trading” stocks? 8

  9. In Defense: Victims of Own Success • Massive increases in areal density enabled massive per-drive cost/BOM reductions (e.g., 3 platters/6 heads down to ½ platter/1 head) • More bang for the buck • With “blended” ASPs falling 15-20% per year it’s tough to grow revenues 9

  10. The HDD market doesn’t lack Unit growth 10 Source: Company reports and Fulcrum Global Partners estimates.

  11. The HDD market doesn’t lack Unit growthBut ASP declines have been brutal 11 Source: Company reports and Fulcrum Global Partners estimates.

  12. …keeping total Revenue from growing 12 Source: Company reports and Fulcrum Global Partners estimates.

  13. …and Gross Margins erratic 13 Source: Company reports and Fulcrum Global Partners estimates.

  14. 2003 Set Up the Golden Chance for Redemption • Moderation in per-drive cost/BOM declines from historical double- to just single-digits, as sweet-spots down to 1 platter/head • New capacity/tech transitions tougher to hit • PC market rebound from 2-year slump • New CE apps (e.g., Xbox, PVR, mp3) finally become primetime and expand demand beyond PCs • Seagate IPO restarts investor interest 14

  15. Recent HDD Stock History: Started Working Late ’02 - early ‘03 Stocks Finally Working, But Wait… 15 Source: Fulcrum Global Partners.

  16. First 9 Months of 2003 • Blended HDD ASPs down just 5% Y/Y • Combined profits of MXO+STX+WDC up 216% to $819 mil from $259 mil • Combined operating cash flow of MXO+STX+WDC up 34% to $997 mil from $745 mil • Combined market capitalization of MXO, STX, WDC, HTCH, KOMG up 140% to $20.4 bil from $8.5 bil ! 16

  17. Recent HDD Stock History: Until 2H03! Doh! 17 Source: Fulcrum Global Partners.

  18. We’d argue moderating Cost declines “SHOULD” have enabled moderating ASP erosion 18 Source: Company reports and Fulcrum Global Partners estimates.

  19. …and Gross Margin stability 19 Source: Company reports and Fulcrum Global Partners estimates.

  20. Missed a Golden Chance! • “Frog and Scorpion” story… is it simply in their “nature”?! • Overbuilding 2H03 led to massive Inventory overhang (e.g., 8-9 mil too many HDDs built 2H03) • Ultra-aggressive pricing • The usual finger-pointing (“other guy”, “channel”, “grey market”, etc.) 20

  21. The Result? WIPE OUT! • 4Q03 - 2Q04 Wiped Out: • Profits • Credibility • $8.7 bil (43%) of combined market cap between MXO, STX, WDC, HTCH, KOMG • Leaving investors to once again ask “are HDDs ever an investment or simply trading stocks?” 21

  22. Most Recurring Investor Questions: • Near-term data points? (e.g., channel inventories, pricing) • Product/Tech developments? (e.g., 40->80GB/p transition, now 120/160?, impact of perpendicular, etc.) • Aren’t HDDs just commodities? Substitutability by design means “roughly yes,” but MOST tech markets have some degree of commoditization, yet it doesn’t mean they all self-destruct • Further Consolidation? • CE opportunity? • Ever act Rationally? …more on 4-6… 22

  23. 4. Further Consolidation? • Consolidation is NO panacea if dynamics/attitudes don’t change • 7 major vendors not necessarily too many • Can help those who don’t consolidate (e.g., WDC when MXO+QNTM, since 1+1 = something < 2) but NOT mkt itself • Traditional SCSI/Ent perhaps needs < 4 mainstream vendors since premium costs + ltd size/growth means should be cash-cow biz • But markets like 2.5in Notebook, while some say getting too crowded, unrealistic to expect anything other than ALL Desktop vendors ultimately being involved • Either way, limited supply simply attracts expansion by incumbents or even new entrants as assembly capacity just too cheap/easy to add 23

  24. Top-3 Desktop HDD vendors already consolidated Market Share 24

  25. 5. CE Opportunity? • New apps finally expand HDD market beyond PCs • Incremental 5% in ’02, 7% in ’03, and we estimate 13% in ’04E, 17% in ’05E • But does this help? • Bottom line…more Units have NEVER been the problem (e.g., a zillion times $0 is still $0) 25

  26. 6. Will HDD Vendors EVER Act “Rationally”? • Back to frog and scorpion • 2003 showed glimmers of hope but ended with overbuilding, inventories…2004 crushed, pricing > cost declines, dumping • HDD assembly mostly a Variable cost model, so why overbuild? • Channel “share” means nothing • Most tech markets have elements of “commoditization” but they don’t all self-destruct • Remember investors seek out Returns on their Capital • Wall Street wants Profits, Growth and Consistency and will REWARD them (2003 proved that). But without them HDDs will NEVER be “investments” and only “trading stocks” 26

  27. What Wall Street WantsCan HDDs Ever Be “Investments” or Only “Trading” Stocks? Needs Rob Cihra Hardware Analyst, Managing Director Fulcrum Global Partners LLC September 2004 27

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