Seagate’s Latest Acquisition Adds To Flash Storage Consolidation

In its recent third fiscal quarter earnings, Seagate Technology (NASDAQ:STX) reported a slowdown in enterprise storage unit sales, with shipments growing by only 2.5% year-on-year to 7.7 million units. Comparatively, the company witnessed a 7% increase in enterprise unit shipments in 2013. ^[1] At the end of last year, Seagate acquired enterprise data storage systems and testing equipment maker Xyratex for $374 million in an effort to enhance its enterprise storage offerings. With the contribution made by Xyratex likely to be accretive starting this quarter, the company remained optimistic that these shipment volumes would pick up in the coming quarters. ^[2]

Then, at the end of May, Seagate announced the acquisition of the flash business from networking semiconductor and chip manufacturer Avago Technology (NASDAQ:AVGO) for $450 million. ^[3] The flash business is crucial to Seagate because of an increasing mix of solid state drives (SSDs), which use flash components, compared to traditional hard disk drives (HDDs). This acquisition continues the trend of consolidation across the storage industry, with major storage companies acquiring smaller specialist manufacturers. For example, over the last few years Western Digital (NASDAQ: WDC) has acquired a number of companies such as Virident, SSD maker sTec and enterprise SSD manufacturer Velobit. 

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Avago Technology And LSI Corporation

Avago Technology is one of the leading manufacturers of networking semiconductors and chips, with a market cap of around $18 billion. Avago announced its intention to acquire storage and networking chip-maker LSI Corporation in a $6.6 billion acquisition in December 2013, with the combined entity expected to generate close to $5 billion in revenues annually. Approximately one-third of its net revenues were expected to come from storage semiconductor sales. ^[4] A few weeks after Avago completed the LSI acquisition, Seagate announced that it will buy LSI’s flash components division.

Back in 2011, LSI sold off its Engenio external disk storage systems business to NetApp (NASDAQ:NTAP) for $480 million. ^[5] However LSI continued its investment in flash storage by acquiring SandForce, a manufacturer and designer of flash memory controllers for SSDs, in early 2012. It is this particular division within LSI which Seagate is set to buy, with the deal expected to close by the end of next quarter.

How LSI’s Flash Business Fits In

Stagnating unit shipments led to a decline in overall revenues for Seagate owing to a decline in the average selling price (ASP) per drive from $63 in Q3 FY 2013 to $61 for the same period in 2014. Consequently, Seagate’s net revenues for the March quarter declined by over 3%, to $3.4 billion, compared to the prior year period. The newly acquired Xyratex is likely to contribute about $100 million to Seagate’s top line in the current quarter, which could help Seagate meet its revenue guidance of $3.3 billion for the coming quarter. However, it would still be a 4% year-on-year decline.

LSI is one of the market leaders with PCI Express SSD technology, which can enhance storage performance of regular storage drives due to the fast connectivity offered. PCIe storage is presently a niche domain, but is expected to mature soon. ^[6] Going forward, LSI’s components business is expected to contribute an estimated $40-50 million per quarter during fiscal 2015. ^[7]

But more than the direct contribution made by just selling flash components, the acquisition adds value on two fronts. Firstly, the sourcing of flash components is likely to become cheaper for Seagate. This could help the company reduce production costs and maintain competitive pricing, which could result in higher unit shipments of enterprise storage products. Secondly, it will help the company to better integrate products with leading flash technology. We estimate that Seagate’s enterprise storage unit shipments will increase from nearly 32 million in 2013 to about 56 million by the end of our forecast period. If the unit shipments increase more our current forecast to about 61 million be the end of the decade, it could imply a 4% upside to our $50 price estimate for Seagate’s stock. Our price estimate is slightly below the current market price.

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1. Seagate Q3 FY 2014 Supplemental Information, Seagate Investor Relations, April 2014 [↩]
2. Seagate Q3 FY 2014 Earnings Call Transcript, Seeking Alpha, April 2014 [↩]
3. Seagate To Buy LSI’s Flash Businesses From Avago For $450 Million, Wall Street Journal, May 2014 [↩]
4. Avago To Acquire LSI: Strong Synergies Plus Diversification, Forbes, December 2013 [↩]
5. NetApp Swallows Engenio In Storage Buyout Bacchanalia, Forbes, May 2011 [↩]
6. PCIe Flash Storage Consolidates: Seagate Buys Avago Tech, Violin Sells To SK Hynix, CRN, June 2014 [↩]
7. Seagate Drops Bomb On Storage Industry, Buys LSI Flash Business From Avago, Forbes, May 2014 [↩]