Seagate Eyes The Flash Array Market With $645 Million Dot Hill Acquisition

Hard drive manufacturer Seagate Technology (NASDAQ:STX) has witnessed slow growth in enterprise-grade hard drive shipments over the last few of years, owing to the increasing mix of solid state drives (SSD) in use. Seagate’s total enterprise hard drive shipments have grown at a CAGR of under 5% from 2010 through 2014 to 33 million drives in calendar year 2014. Comparatively, the enterprise SSD market has shot up in in the same period. According to Storage Newsletter, the enterprise SSD market is expected to reach $4 billion in revenues by 2016, nearly six times where it was in 2011, while unit shipments are expected to increase by ten times during that period. ^[1] Furthermore, a key growth area for storage providers is the growing demand for flash arrays or storage racks that use SSDs instead of hard drives. In an attempt to cater to a broader customer base, Seagate announced the acquisition of storage array and storage software provider Dot Hill Systems for $645 million in an all-cash transaction. ^[2]

We have a $56 price estimate for Seagate’s stock, which is slightly higher than the current market price. Seagate’s stock price has fallen by about 25% since the beginning of the year. The company has agreed to purchase Dot Hill systems at $9.75 per share, which was an 88% premium to the most recent stock price before the announcement and a 50% premium over the preceding three month stock price average of Dot Hill.

See Our Full Analysis For Seagate’s stock

Integrating Dot Hill Storage And Possible Impact

Dot Hill Storage is a provider of storage arrays and virtualization software solutions for a vast array of customers ranging from small and medium businesses (SMBs) to enterprise OEMs. The company has an enterprise value of $645 million; the acquisition is likely to be completed by the end of the year, and its results will be accretive to Seagate’s earnings in the latter half of the company’s fiscal 2016 ended June.

Dot Hill sells storage-area network (SAN) arrays to clients across various industries including telecom, oil & gas, digital imaging, analytics and big data. The company has a tiered storage architecture, using both SSDs and enterprise-grade hard drives in the storage racks. The hybrid flash array (HFA) or network-based storage system that utilizes both flash media and traditional spinning disks in its storage architecture. This configuration balances the cost vs performance dilemma for most customers. Using SSDs in the capacity ranging from 2% to 5% of total available storage can effectively improve the total input/output operations per second (IOPS) by almost 100% and reduce latency from 10 milliseconds to as low as 3 milliseconds. ^[3] Although this is higher than the <1 milliseconds latency offered by a many all-flash arrays (AFA), the total cost of owning a HFA is typically lower than an AFA. As a result, the HFA market is currently considerably larger than the AFA market. According to IDC, the HFA market stood at about $10 billion in 2014 while the AFA market size was estimated at about $1.3 billion for the year. ^[4] HFA is expected to become a $14 billion market through 2018, while the AFA market is expected to grow at a faster pace to become a $3.5 billion market by 2018. ^[5]

The integration of Dot Hill within Seagate could lead to cost synergies, enabling Dot Hill arrays to source Seagate hard drives at possibly lower costs than competing array makers. Furthermore, Seagate already has data storage testing equipment maker Xyratex and LCI’s PCI Express SSD storage technology under its belt. Additionally, Dot Hill sells storage software bundled with its products that include data migration software tools, backup & data recovery software suites and virtualization compatible with both VMware (NYSE:VMW) and Citrix Systems. A converged solution with the aforementioned capabilities could provide meaningful growth for the company. According to Dot Hill’s management, the company expects non-GAAP revenue of about $250 million for 2015. ^[6]

Starting from early 2016, Seagate can position itself to compete with storage systems vendors such as EMC (NYSE:EMC) and NetApp (NASDAQ:NTAP) in addition to rival Western Digital (NASDAQ:WDC). Other companies that are active in the flash array arena include computing giant IBM (NYSE:IBM) and a number of small vendors including Pure Storage, Violin Memory, SolidFire, Kaminaro and Nimbus Data.

Continued Consolidation Across The Storage Industry

EMC has been active in the market over the last few years, enhancing its flash storage and cloud infrastructure capabilities. The company acquired cloud computing management software and infrastructure-as-a-service (IaaS) provider Virtustream for $1.2 billion in May this year and flash chip-maker DSSD in May 2014. EMC acquired flash array maker XtremIO in 2012 and released its first all-flash array in late 2013. Similar to the Dot Hill acquisition, SanDisk (NASDAQ:SNDK) acquired storage hardware and software systems manufacturer Fusion-io for approximately $1.1 billion in June 2014. Additionally, SanDisk acquired enterprise class SSD manufacturer SMART Storage Systems for about $307 million in July 2013.

Leading hard drive makers Seagate and Western Digital have acquired flash storage companies and startups over the last few years to boost SSD sales and to complement their hard drive businesses. Since 2013, Western Digital acquired a number of companies such as Virident, SSD maker sTec and enterprise SSD manufacturer Velobit. Similarly, Seagate acquired enterprise data storage systems and testing equipment maker Xyratex for $374 million in late 2013 to enhance its enterprise storage offerings. To add to the Xyratex acquisition, Seagate announced the acquisition of LSI’s Flash Components Division and Accelerated Solution Division from networking semiconductor and chip manufacturer Avago Technology (NASDAQ:AVGO) for $450 million in May 2014.

Seagate’s enterprise storage division has posted solid numbers in 2015 thus far. Enterprise HDD unit shipments have risen by almost 15% year-over-year to 17.3 million units through the first two quarters of calendar year 2015. We estimate that Seagate’s enterprise storage unit shipments will increase from 33 million in 2014 to over 60 million by the end of our forecast period. If the unit shipments increase more our current forecast to about 65 million be the end of the decade, it could imply a 7-8% upside to our $56 price estimate for Seagate’s stock.

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1. Enterprise SSDs to Grow Over 10x by 2016, Storage Newsletter, November 2012 [↩]
2. Seagate Technology To Acquire Dot Hill Systems, Seagate Press Release, August 2015 [↩]
3. Hybrid storage arrays vs. all-flash arrays: A little flash or a lot?, Search Solid State Storage, January 2014 [↩]
4. Flash-Based Array Market Proving to Be More Than Just a Flash in the Pan as Market Soars Past $11 Billion in 2014, IDC Press Release, January 2015 [↩]
5. The Flash Based Array Market, Storage Networking Industry Association, April 2015 [↩]
6. Seagate to Buy Dot Hill to Enhance Cloud Offerings, Wall Street Journal, August 2015 [↩]