The digital storage industry is evolving, and there are two game-changing companies that every tech investor should be familiar with: Western Digital Corp. (NASDAQ:WDC) and Seagate Technology PLC (NASDAQ:STX). Western Digital and Seagate produce the majority of the world’s hard disk drives (HDDs), controlling 45% and 42% of the market, respectively. However, two concerns have weighed on these two companies over the past few years — the rapid decline of PC sales and the rise of solid state drives (SSDs).
Let’s examine the bear and bull cases for these hard drive makers and see if they are at the forefront of technological evolution, or if they are being left behind.
What the bears say
PC makers are traditionally Western Digital Corp. (NASDAQ:WDC) and Seagate’s largest customers. However, research firm IDC recently forecast that global PC shipments in the first quarter will fall 13.9% from the previous year, continuing the market’s decline due to rising demand for smartphones and tablets. Smartphones and tablets use internal flash memory and removable flash media, which are more compact and power efficient than traditional platter-based hard drives.
Meanwhile, Ultrabooks (higher-end laptops) use solid state drives, which use similar technology as flash-based memory. SSDs feature smaller storage capacities, faster access times and higher reliability, due to the lack of physically moving parts inside the drives.
SSDs still cost more than HDDs. A 500 GB SSD costs $330 to $450, while its 500 GB HDD counterpart costs a mere $60 to $100. However, that gap is closing quickly, and analysts believe that higher-capacity, comparably priced SSDs will eventually render HDDs obsolete. HDD sales are expected to drop 12% throughout 2013 as a result.
Although Western Digital Corp. (NASDAQ:WDC) and Seagate dominate the HDD market, the SSD market is controlled by other players that emerged from manufacturing flash memory — such as Fusion-IO, Inc. (NYSE:FIO). To keep up, Seagate acquired Samsung’s disk drive business last March for $1.4 billion, and Western Digital bought Hitachi GST (Global Storage Technologies) for $4.8 billion last June. Both Samsung and Hitachi’s storage segments contain SSD products, although their market footprints are still smaller than Fusion-io’s.
What the bulls say
Despite all the fuss regarding the rise of SSDs and the demise of HDDs, SSDs still actually only comprise a minor part of the market, as seen in the following chart compiled by research firm IHS iSuppli.
IHS forecasts that the HDD market in 2012, worth $37 billion, will drop to $33 billion in 2013 and $32 billion by 2014. Yet the bulk of the market will still need rigid disk drives, or HDDs, despite the rise of tablets and other hybrid devices using SSDs.
Although Western Digital Corp. (NASDAQ:WDC) and Seagate expect to lose customers due to the decline of PCs, strong demand from enterprise customers, which need cost-effective storage solutions for their cloud-based servers, will prefer traditional HDDs, which offer higher capacities for lower prices. For example, Western Digital’s enterprise sales rose from 1.7 million to 6.6 million units year-on-year last quarter.
The frenzy over cloud-based storage and streaming is at the heart of this growth. Popular cloud-based software, such as Google Inc (NASDAQ:GOOG) Drive, Microsoft Corporation (NASDAQ:MSFT) Skydrive, Dropbox and Apple Inc. (NASDAQ:AAPL) iCloud are all soaring in popularity as consumers realize the convenience of being able to easily access their content across multiple platforms, such as smartphones, tablets and personal computers.
Meanwhile, streaming video services such as YouTube, Netflix, Inc. (NASDAQ:NFLX), Amazon.com, Inc. (NASDAQ:AMZN) Video, Hulu and Pandora Media Inc (NYSE:P) all require massive storage capacities on the server side. Messages delivered via social media platforms such as Facebook Inc (NASDAQ:FB) or delivered via traditional email also require lots of bandwidth.
As a result, Cisco estimates that global cloud traffic will grow 45% annually over the next three years, and 20% of that data will be used for content consumption purposes. However, whether or not all that streaming content will be stored on traditional HDD servers simply due to the cost-to-storage ratio remains a point of contention between bears and bulls.
Has the future arrived early?
For Western Digital and Seagate shareholders, recent news indicating that both Apple and Facebook are favoring Fusion-io’s more expensive SSD technology to power their cloud-based servers is worrisome. In fact, orders from Apple and Facebook currently account for 50% of Fusion-io’s revenue. If Apple and Facebook, two companies that are regarded as ‘bleeding edge’ technology companies, favor Fusion-io and SSD servers, does that mean Google and Amazon are far behind?
I believe that Western Digital Corp. (NASDAQ:WDC) and Seagate Technology PLC (NASDAQ:STX) investors shouldn’t worry. Apple and Facebook have the capital to afford this kind of investment; other smaller companies simply do not. Considering the shaky state of the U.S. economy, with spending cuts impacting many businesses, I believe that industry-wide upgrades to full SSD servers (flash arrays) are unlikely in the near future.
At the end of January, Apple and Facebook actually delayed their orders from Fusion-io, causing its shares to plunge 21%. To make matters worse, Fusion-io’s third largest customer is struggling tech giant Hewlett-Packard Company (NYSE:HPQ), which accounted for 19% of its revenue last year. Therefore, I believe that Western Digital and Seagate, which have a wider variety of customers, are much safer bets in the digital storage industry.