The last time SeagateTechnology (NYSE: STX ) investors threw a block party in their corner of the stock market, the firm had just laid off 3,000 employees because of declining market share and pricing pressure. Wednesday was different. Wednesday, you see, the hard drive maker announced it would pony up $1.9 billion worth of its stock to buy struggling peer Maxtor (NYSE: MXO ) .
But the cheering was no less audible. Shares of Maxtor climbed more than 53% on the day while investors bid up Seagate by roughly 3%. Is the enthusiasm warranted? Those on Wall Street seem to think so. Dozens of media reports quoted plenty of pundits as bullish on the news. For example, Standard & Poor's analyst Richard Stice told Bloomberg that the deal was a good one because there's " ... a lot of opportunity in this industry right now."
That's likely a reference to the bulked-up nature of smaller devices, such as the Apple iPod, which now use hard drives, many of which are manufactured by Seagate. Microsoft's (Nasdaq: MSFT ) Xbox 360 also relies on Seagate drives.
But remember, too, that this is, well, the hard drive market we're talking about. Data storage is a capital-intensive business. And drives command some of the lowest gross margins in the high tech industry.
So why in the world are investors cheering this deal? Because it often pays to be one of the last few standing in a business that's necessary but unattractive. Hard drives fit that mold. So do PCs. In fact, Motley Fool Stock Advisor pick Dell (Nasdaq: DELL ) is a great example of how to profit in an aging, low-margin market. Think about it. Dell has banished IBMto China, Hewlett-Packard (NYSE: HPQ ) into a series of fits and starts, and Gateway (NYSE: GTW ) into teetering irrelevance. Only Apple stands out as a thriving competitor in the personal computing market, and the iPod deserves much of the credit for that.
In absorbing Maxtor, Seagate will bolster its role as top dog in drives with a market share north of 40%. The deal should also help boost cash flow after the firm imposes manufacturing and engineering efficiencies on an increased revenue base. And that, in turn, should finally allow it to put pressure on larger rivals such as Hitachi (NYSE: HIT ) and Toshiba.
Can Seagate ape Dell's efficiency, thereby capturing similarly dreamy returns for shareholders? I doubt it. But that's not really necessary, for come summer of 2006, when this deal is expected to close, the drive maker should be a lot more competitive than it is today. And that's for a stock that's trading at a relatively meager 11 times earnings and boasts a whopping 39% return on equity. Tech shares almost never get that cheap. And when they do, they don't stay that way for long.
Boot up your investing knowledge with related Foolishness:
- Is Seagate the Rodney Dangerfield of the storage world?
- Maxtor was clinging to life in August.
- Oh, how things have changed from the sadistically sad tale Seagate spun last June.
High tech. Biotech.Nanotech. Any tech. David Gardner and his merry band of Foolish analysts cover it all forMotley Fool Rule Breakerssubscribers. And they're profiting handsomely: The portfolio is beating the market by more than 14% as of this writing. Get in on the action by taking a risk-free 30-day trial. Or sign up today and David will buy your copy ofStocks 2006, which includes our analysts' best picks for the year. Either way, all you have to lose is the prospect of better returns.
Microsoft is aMotley Fool Inside Valuepick.
Fools, now is the time to open your hearts and wallets to worthy causes! Please support our five Foolish charities at www.foolanthropy.com.
Fool contributor Tim Beyers remembers what booting up a computer used to be like. Ah, the good 'ol days. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking Tim's Fool profile. The Motley Fool has an ironclad disclosure policy.