You're Exactly Wrong to Be Selling Seagate

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And so it ends. Seagate Technology (Nasdaq: STX  ) has called it quits. The buyout talks with TPG Capital have fallen through. And, yes, I suppose you could call it "bad news." Investors certainly think so, selling the stock off hard in afterhours trading yesterday. But I disagree.

On Monday, Seagate confirmed that TPG Capital had been unable to find enough partners to go in with it on a deal to take the company private. Hence, "management and the board have chosen to cease discussions." But don't think for a minute that means no one wants to buy Seagate. If private equity won't step up to the plate, says Seagate, it'll just go ahead and buy itself.

Citing the cheapness of debt these days, along with its own "improving business conditions," which enable Seagate to generate copious free cash flow, management promised last night to initiate a $2 billion share repurchase plan -- essentially buying when Wall Street won't. That's exactly the right call to make, and investors who dumped the shares last night on fears their "acquisition premium" just blew up were exactly wrong to be selling. Here's why.

A bargain is still a bargain
Hard-disk-drive makers like Seagate and Western Digital (NYSE: WDC  ) have been doing their part to reduce unemployment in America lately, giving a huge boost to the epitaph-writing industry. To hear pundits tell it, Apple's iPad and the host of wannabe pads issuing from the likes of Samsung and Cisco mark a sea change in the computer industry. Henceforth, the growth companies are Flash mnemonics Micron (Nasdaq: MU  ) , SanDisk (Nasdaq: SNDK  ) , Smart Modular (Nasdaq: SMOD  ) , and STEC (Nasdaq: STEC  ) . There's no love left for Seagate.

Except, if that were true, why was TPG trying to buy Seagate in the first place? Why did Silver Lake try to buy it before them? The answer is this: Seagate stock is screamingly cheap.

Selling for less than 4.5 times its past year's profit, Seagate stock is priced to move even if the company misses Wall Street's consensus long-term growth estimate of 10%. To believe today's price is anywhere near "fair value" requires that you assume Seagate will miss that estimate by half. And call me an optimist, but even I don't think Wall Street is off by that much.

Even if prospects look better for Flash and solid-state drives than for HDDs, there's still room in this world for both. There's still a case to be made for Seagate, and the more the stock slides, the stronger that case becomes.

The Fool has written calls (bull call spread) on Cisco Systems, and Fool contributor Rich Smith owns shares of Western Digital. The Motley Fool has a disclosure policy.

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Read/Post Comments (4) | Recommend This Article (7)

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  • Report this Comment On November 30, 2010, at 3:00 PM, EquityBull wrote:

    Good article. You are spot on. Also the most likely replacement of the hard drive on desktops and servers is going to by a Hybrid drive like Seagate's Momentus XT. Combining a traditional drive with SSD gives performance and capacity. Stick an on board controller to handle the dance and this is the replacement paradigm for the next 10 years.

    Seagate is cheap here so don't be surprised if another suitor comes along

  • Report this Comment On November 30, 2010, at 3:28 PM, CMFSoloFool wrote:

    The trouble I see with this plan is that Seagate already carries a lot of debt, their Debt/Equity ratio is 0.74. Even at the cheap interest rates, that is still scary high debt.

    This is one of the principal reasons why I shunned STX and went with WDC instead, which is much stronger on the balance sheet, and has a Debt/Equity ratio of just 0.08. I do believe STX is somewhat undervalued, but by the same measure I believe WDC is even more undervalued, and therefore a better buy.

  • Report this Comment On November 30, 2010, at 9:44 PM, TMFDitty wrote:

    @FoolSolo: A lot of debt, yes -- but they also have a lot of cash. Enough to fund the entire buyback out of their bank account, in fact. ('Course, that will leave them with all the debt, and none of the cash.)

  • Report this Comment On November 30, 2010, at 9:59 PM, jrmart wrote:

    Yes sir, it's true, the horse and buggy still survives in Central Park, NYC.

    In the 80's, a 25 MB mini computer slow spinning hard drive cost $65,000. It was 2 feet wide by 2 feet high and shook like crazy. I know, because I sold a lot of them. Today you can buy a 16 GB solid state USB drive for $20.

    When it comes to fast data searches, you can buy 2 ZEUS solid state drives from STEC to replace 300 15,000 RPM hard drives from Seagate, thereby saving tons of money on power, air conditioning, maintenance and space costs.

    Seagate would be better off spending their billions either buying STEC or SanDisk.

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