Seagate Technology PLC (STX): Cheap and High Yielding… But Is It Worth It?

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I’ve been on the hunt for bargains lately. A company that recently stood out was Seagate Technology PLC (NASDAQ:STX). At a very superficial first glance, the company looks like a bargain. It trades at a P/E of under 5, with a forward P/E of about 6.7. It yields over 4%, which is awesome. But is this company truly a bargain, or is it a value trap– lagging the market for a reason? Let’s take a deeper look.

A duopolistic storage king

The company’s cheap valuation and high yield are positives initially. Nothing like buying a cheap stock and collecting a great stream of income, while waiting for the market to realize they left behind a good company. The company also has a large share of most of the markets it operates in. It also dominates in these saturated markets for the most part, with Western Digital Corp. (NASDAQ:WDC) usually being its sole competition.

Seagate Technology PLC (NASDAQ:STX) controls around an estimated 40% share of the hard-disk drive market, with competitor Western Digital owning another 45%. Being second, but by a long-shot compared to those below you in a saturated market, can often be a strength — as barriers to entry are high. So why not consider Western Digital Corp. (NASDAQ:WDC)? Because yielding only 2%, Western Digital Corp. (NASDAQ:WDC) makes me like Seagate Technology PLC (NASDAQ:STX) and its 4% dividend yield twice as much.

Falling knife or double-edged sword?

Seagate seems to be a very cyclical company, and a recession may mean a quick and sudden drop in already seemingly sporadic and unpredictable earnings. A global recovery and a pick-up in enterprise could also mean really good prospects for earnings, however, so know that Seagate Technology PLC (NASDAQ:STX) may be a double-edged sword.

Another thing to watch closely if considering an investment in Seagate is its balance sheet — as debt looks to be much higher than many other tech companies.

Is there a cloud over the moat?

Cloud computing needs storage. As a major player in a duopolistic storage market, a pick-up in enterprise data-centers and cloud computing may be the drawbridge that allows Seagate to cross its more PC-related moat to discover more growth, as well as new markets.

Seagate may make a good play on increasing cloud-related data storage, more so even than current leaders in the public cloud space, such as Amazon.com, Inc. (NASDAQ:AMZN), Google Inc (NASDAQ:GOOG), and Microsoft Corporation (NASDAQ:MSFT). All three of these cloud giants seem to be engaged in a price war.

While Amazon web services (AWS) is expected to double revenue this year (which also works out to be around 5% of sales), there is a problem. Amazon already had minuscule margins of only around 1.11% for 2012, as compared to over 25% for Google and Microsoft Corporation (NASDAQ:MSFT).

Bloomberg author Ari Levy thinks this is good, explaining that “Amazon can cut prices on cloud services without “affecting its total profitability” because “Investors aren’t fazed by Amazon.com, Inc. (NASDAQ:AMZN)’s low margins.” As Amazon’s stock continues to defy gravity and remain richly valued, even with negative earnings, Levy may have a point.

This is why Microsoft Corporation (NASDAQ:MSFT) and Google Inc (NASDAQ:GOOG), who are also increasingly beginning to battle over the enterprise apps markets (as Google is trying to eat some of Microsoft’s lucrative Office pie), may end up being dragged down and required to continue to lower their margins also — to compete with Amazon.com, Inc. (NASDAQ:AMZN).

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