Rumblings of Drive Price War Start to Rattle Western Digital

Orange County Business Journal, May 5-May 11, 2008 by Tolkoff, Sarah

Wall Street's concerns about price wars for disk drives could spell the end of Western Digital Corp.'s long run-up.

The Lake Forest-based drive maker's stock has been on a tear-its shares are up more than 50% in the past year with a market value of about $6.5 billion last week.

The company has been riding high amid stable supplies and prices for disk drives, as well as market share gains in drives sold at stores and used in laptop computers.

Key rival Scotts Valley-based Seagate Technology LLC has seen a similar, though less dramatic, run-up in the past year.

But Western Digital's shares have reversed course recently, slipping about 5% last week. They're off about 15% since their recent peak at the end of February.

The trouble started with Seagate, which last month cut its outlook for the June quarter and reported March-quarter earnings that were in line with expectations but revenue fell short.

The culprit: price cutting on drives by Western Digital and Hitachi Ltd., according to Seagate.

Western Digital itself reported strong results for the March quarter and gave a positive outlook for the current one. But it did say it saw price cutting and shut down production for a week at the end of the quarter to meet lessened demand.

"Although Western Digital's March results weren't affected, pricing is beginning to make an impact for the June quarter," said Keith Bacnrnan, an analyst at BMO Capital Markets Corp. in New York.

Seagate also is cutting prices, according to Bachman: "We believe that despite Seagate's comments to the contrary, the company is using price as a weapon, to some extent, to gain market share for new products from Western Digital."

Undercutting is nothing new among drive makers-the industry is known for occasional price wars and oversupplies of drives.

"The drive business continues to be a competitive business," Western Digital Chief Executive John Coyne said on a recent call with analysts. "We did see some greater than anticipated pricing action in late March, particularly."

Lower average selling prices-or what Western Digital can charge customers for its drives-means lower profits.

During the March quarter, the average drive selling price was $59, down $2 from the December quarter and up Sl from a year earlier.

Prices typically fall about 3% to 4% from the March quarter to the June quarter, the slowest time for Western Digital and other drive makers in terms of sales.

BMO Capital analyst Bachman said he sees drives going for $56 in the current quarter.

Analysts also are concerned about a possible drive glut, which would further drag down prices.

They took it as a bad sign that Western Digital voluntarily shut down production at some factories toward the end of the first quarter to reduce the amount of drives on the market.

"In our view, the factory shutdown is an indication that demand was waning late in the quarter," Bachman said in a research note.

Western Digital is "at a negative inflection point," analyst Shebly Seyrafi of Caris & Co. in New York said in a note to clients.

He said he's cautious about the company's prospects through June on the possibility of slimmer profits and the prospect for "aggressive pricing at the end of the June quarter."

All of these factors overshadowed the company's results for the March quarter, which one analyst called "stellar."

Profits more than doubled from a year earlier and revenue jumped by 50%, handily beating Wall Street expectations.

Western Digital posted profits of $280 million, up from $121 million a year earlier. Sales went from $1.41 billion to $2.11 billion.

"The company reported a tremendous quarter," said Richard Kugele, analyst at Needham & Co. in New York. "Name another company in tech that showed that kind of growth. This is clearly a company that's executing well."

He's said he's not convinced Wall Street is giving Western Digital a fair shake and called the stock "cheap."

Kugele has a "strong buy" rating on the shares and said the company is "compelling at current levels."

He's expecting Western Digital's stock to bounce back by the summer.

"Over the next four weeks you will hear of continued average selling price declines, but by the end of May demand will get better and by mid-June, things are humming," he said. "Then you get into July and you are off to the races."

For the current quarter, Western Digital sees a profit of $171 million to $184 million on revenue of $1.8 billion to $1.9 billion.

Analysts on average expect a profit of $162 million on sales of $1.87 billion.