What Do Recent Seagate Technologies & Western Digital Acquisitions Mean For Fusion-IO?

During Fusion-IO's (NYSE: FIO  ) 66% stock price loss since its 2011 IPO, it has been the center of acquisition rumors. The seemingly continuous spending spree on flash storage product companies all but adds fuel to this fire. However, as we look at the latest acquisition by Seagate Technologies (NASDAQ: STX  ) and look back to those by Western Digital (NASDAQ: WDC  ) , the inevitable outcome for Fusion-IO might not be what's expected.

A buying spree that creates logical speculation
Fusion-IO develops flash memory modules for high-performance applications, which is largely considered a growth industry given increased data and more advanced consumer and enterprise technology. Last year, hard disk drive (HDD) manufacturer Western Digital acquired Virident , which is nearly the equivalent of Fusion-IO, for $685 million.

The purpose of Western Digital's acquisition was widely believed to increase its visibility in the fast-growing solid state drive (SSD) market. In this memory market, HDDs are used in PCs and laptops while SSDs are often found in smartphones and tablets. Clearly, the latter is where growth exists. As a result, this acquisition is what really set Fusion-IO buyout talks in motion, or at least made the discussion serious.

Western Digital added fuel to this fire with the acquisition of sTec , a solid state drive maker, for $340 million cash. Afterwords, Western Digital acquired an SSD caching software company called VeloBit , all in the goal of making its SSD business sustainable. Since then, Western Digital's SSD sales have been explosive, albeit still roughly 5% of total revenue. Nonetheless, these acquisitions led many to think that Seagate, Western's HDD peer, would make a move to acquire Fusion-IO.

Latest buy creates substantial doubt
Since April, shares of Fusion-IO have fallen more than 25%. This fall was sparked when its most likely suitor, Seagate, acquired Xyratex . Granted, Xyratex has a smaller presence in storage, but this surprised Fusion-IO investors nonetheless. Perhaps the biggest blow to Fusion-IO investors came last week, when Seagate made an aggressive acquisition in the flash market by acquiring one of Fusion-IO's biggest competitors for $450 million, a segment of LSI .

When you connect all the dots, it doesn't appear than any of the likely suitors are looking to acquire Fusion-IO. Instead, they're poised to compete against it. This is a company that has attempted to be competitive in all avenues of its business, especially pricing and research, in order to grow and attract customers. The end result has been operating margins of negative 25% and growth rates that have fallen substantially in the last two years. This shows that its initiatives aren't paying off.

In fact, with $380 million in annual revenue, Fusion-IO appears by all measures to be a small competitor of Western Digital and Seagate Technologies, two companies with $15 billion and $14 billion in annual revenue, respectively. Both Western Digital and Seagate have great scale, and a market-leading presence in memory drives. This is likely to affect Fusion-IO in a negative way.

Final thoughts
Combined, Western Digital and Seagate Technologies own 85% of the HDD market. Both have become large through mergers and acquisitions. Clearly, both companies are implementing the same strategy with SSD, but so far are staying clear of Fusion-IO.

If you consider the Virident acquisition and others, Fusion-IO's takeout value is worth $22-$27 per share.. Therefore, at $8 you'd think someone would gobble it up as a value opportunity. However, for high-margin companies like Western Digital and Seagate, Fusion-IO's lack of efficiency creates many questions on the sustainability of its business model. This might be the driving force for why no such buyout has occurred.

As a result, potential acquirers have now become enormous competitors, which means that Fusion-IO's shares could suffer further. Looking far ahead, any acquisition will be at a significantly lower price when Fusion-IO's shares fall due to competition. Once they reach a level that is too attractive to pass up, the offers may come. Regardless, Fusion-IO doesn't look good right now.

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