Seagate Is a HDD Pure-Play, Leading to Cyclical Results and Eroding a Moat

Analyst

William Kerwin

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Seagate is a leading designer and manufacturer of hard disk drives, or HDD, used for data storage in consumer and enterprise applications. We think Seagate is successfully transitioning its portfolio to focus on mass-capacity drives for cloud providers and enterprises as consumer applications for legacy HDDs switch to faster flash-based solid-state drives. We expect continued demand for mass-capacity drives over the next five years as enterprises look to capture more data and use a multitier storage approach, implementing both mass-capacity HDDs and smaller enterprise-grade SSDs as complements in data centers. Seagate has consistently driven costs down for its mass-capacity HDDs by advancing to larger capacities, and we think it will continue to do so by leveraging new technologies like heat-assisted magnetic recording. 

We expect mass-capacity HDD demand to offset declines in consumer HDDs over the next five years, but we don’t think Seagate’s drives allow it to establish an economic moat. We think HDDs are commoditylike even at the enterprise level, with Seagate and Western Digital matching each other’s technological roadmaps and competing with one another for volume, preventing both from earning pricing power. In periods of tight supply and favorable pricing, the firm can earn excess returns on invested capital, but when the market hits oversupply, pricing falls, bringing Seagate’s economic profits with it. 

We expect Seagate will focus on expanding to new capacities for its enterprise drives while implementing new technologies like heat-assisted magnetic recording that will help it drive costs down and expand margins. Still, we think technological advancements like these will be matched by rivals and won’t shield Seagate from cyclical market downturns. Longer term, we expect demand for mass-capacity drives to slow as the cost gap with enterprise SSDs narrows further. We think Seagate will try to create new growth opportunities through its modulelike Lyve platform, which layers software onto multiple drives, but we don’t think this business is large enough to offset a secular decline in HDD sales.

Business Strategy & Outlook

We don’t think Seagate possesses an economic moat. Seagate is a leader in the hard disk drive market, which doesn’t offer its participants moats, in our view. HDDs are one of two predominant data storage technologies (the other being flash). While the HDD market is characterized by high barriers to entry and massive capital investment, it also features a rapid commoditization curve and mostly fungible products that we think erode firms’ ability to reliably earn excess returns on invested capital. We acknowledge that Seagate is able to earn economic profits when demand is strong and supply is tight, but any overinvestment in the industry leading to oversupply can crater pricing and leave the firm liable for economic losses. 

The HDD market is an oligopoly—but practically a duopoly—with Western Digital and Seagate each controlling roughly 40% of the market and Toshiba playing a bit part with less than 20% share. HDDs serve two distinct market segments: consumer drives for computers and gaming and mass-capacity enterprise drives for data centers. The former segment is undergoing a rapid decline, as solid-state drives built with NAND flash take over the consumer market. Compared with HDDs, SSDs are smaller, more durable, more energy efficient, and much faster. They are also more expensive, which has historically been the bottleneck to full-scale adoption. However, the price discrepancy between HDD and SSD tech has been narrowing quickly as flash technology advances, and we think SSDs now present an overall better value proposition for consumer devices than HDDs. Consumer SSDs now cost about double what a comparable HDD would cost, and consumers are increasingly opting to pay the roughly $50 extra (for a 1 terabyte drive) for the improved performance of an SSD. We expect the cost gap between consumer SSDs and HDDs will continue to narrow, and think that by 2025 consumer HDDs will be all but extinct. 

Conversely, for mass-capacity enterprise drives (also known as nearline drives) the cost discrepancy between HDD magnetic recording technology and flash is material. Western and Seagate are constantly improving areal storage density and implementing new technologies like heat-assisted magnetic recording, or HAMR, to drive cost per HDD gigabyte down further at large capacity points. As a result, enterprise SSDs are still about 6-10 times more expensive than a comparable HDD, according to TrendFocus and Seagate management. We think the crossover point for majority SSD adoption in mass-capacity drives is years away. Data centers are already implementing SSDs in data centers as complements to mass-capacity HDDs, which achieves a healthy balance of speed and cost. Mass-capacity HDDs hold the vast majority of data, and only “hot data”—newer data that is expected to be accessed frequently—gets stored on enterprise SSDs for quicker access. The cost gap between enterprise SSDs and HDDs is narrowing, but we expect HDDs to continue storing the majority of data. Even with a tiered setup, enterprises are still losing 44% of the data they generate, according to IDC. So long as data is going unstored, we expect cloud and enterprise customers to demand greater capacity at both HDD and flash storage tiers to store more data at a low cost. 

While we expect nearline HDD demand to persist over the next 10 years, we still don’t think Seagate’s nearline business contributes to a moat, as we believe economic profits aren’t durable through the course of a demand cycle. 

We think both Western Digital and Seagate possess significant intangible assets in the design and manufacture of mass-capacity HDDs, but are unable to translate these into pricing power and long-term economic profits. Competition in nearline HDDs occurs primarily on the basis of capacity expansion and lowering the total cost of ownership, or TCO, at customers. Western and Seagate are constantly developing higher capacity drives for enterprises and have roadmaps to 30 TB and beyond. In addition to adding capacity, new technologies like HAMR and dual actuators help to increase speeds and lower TCO at larger capacities. Technological advances have kept enterprise HDDs well ahead of the SSD cost curve and are continuing to meet demand for greater capacity and lower cost at customers, but we think differentiation between two competing drives with equal capacities is negligible. In our view, deciding between a drive from Western Digital or from Seagate is largely based on customer preference. Data center operators have teams of engineers that work to integrate disparate computing, networking, and storage technologies together, and each data center is built to differing specifications. In fact, cloud and enterprise customers typically dual- or multi-source their mass-capacity drives. A given data center likely has HDDs from both Western Digital and Seagate (and potentially Toshiba) for different applications. We also think that relatively constant market shares for Western Digital and Seagate in the nearline market are evidence that neither has been able to gain a technological lead over the other. The true differentiation for enterprise hard drives is capacity, and there have been instances where one side of the duopoly beat the other to a capacity node. For example, Seagate was the first to ship 16 TB drives, and won enterprise market share from Western Digital in 2020 because of it. Nonetheless, we think market shares normalize over time throughout these short-term fluctuations as customers look to dual-source and keep costs down. We think that negligible product differentiation and ubiquitous dual-sourcing erodes pricing power for any HDD supplier, which is evidenced by Seagate and Western’s HDD business having practically identical gross margins. 

We also think Western Digital and Seagate can produce HDDs at a lower cost than Toshiba or any other potential entrant, but think one would have to gain a material cost advantage over the other to earn economic profits—a scenario we don’t expect to play out. Western Digital and Seagate are vertically integrated HDD designers and manufacturers, while Toshiba sources its recording media and other components externally. HDD manufacturing requires hefty up-front investment, with both Western Digital and Seagate putting more than $500 million toward HDD capital expenditures and upward of $1 billion into HDD research and development annually. We think Western and Seagate can leverage this fixed investment, selling large volumes of drives to drive average cost per drive lower and out of reach of Toshiba or a new entrant. Even so, Western and Seagate’s competition with one another for volume prevents either from shipping enough drives to earn enduring excess returns on its invested capital, in our view. Both firms are able to earn economic profits when demand is strong and supply is tight, but any glut of supply can cause prices to sink, bringing economic profits with them, as seen in 2016 and 2019. With current competitive dynamics in place, we think Seagate would need to earn a cost advantage over Western Digital to maintain economic profits over the long term, and we think similar free cash flow margins for Western and Seagate demonstrate that neither has earned a cost advantage over the other. We also expect both firms to continue competing rationally. Even if one firm tried to undercut the other on price to gain market share, we would expect share gains to revert back once pricing returned to parity. We think Seagate has developed formidable HDD leadership, but that steep competition minimizes the material product differentiation or economies of scale that would be needed for it to carve out an economic moat.

None

Economic Moat

Seagate Technology Holdings PLC

LaCie is a French computer hardware company specializing in external hard drives, RAID arrays, optical drives, Flash Drives, and computer monitors. The company markets several lines of hard drives with a capacity of up to many terabytes of data, with a choice of interfaces (FireWire 400, FireWire 800, eSATA, USB 2.0, USB 3.0, Thunderbolt, and Ethernet). LaCie also has a series of mobile bus-powered hard drives.

LaCie

Seagate Technology PLC (commonly referred to as Seagate) is an American data storage company. It was incorporated in 1978, as Shugart Technology. Since 2010, the company is incorporated in Dublin, Ireland, with operational headquarters in Cupertino, California, United States.

Seagate Technology PLC

Seagate Technology Holdings Plc operates as holding company that is engaged in the development, production, and distribution of data storage products and electronic data storage solutions. Its products include hard disk drives, solid state hybrid drives, solid state drives, peripheral component interconnect express cards, serial advanced technology attachment controllers, storage subsystems and computing solutions. The firm offers its products under the Backup Plus and Expansion product lines, and Maxtor and LaCie brands. The company is founded in 2012 and is headquartered in Dublin, Ireland.

Earnings data Q2 2023

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