Post of the Day
April 08, 1998

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Boring Stocks Board

Subject: Re: SEG and AMAT and EMC
Author: MarkM10073

"I admit to being shy about the disk drive makers. How about EMC, though? Do you follow that? Like so many stocks, fairly expensive right now; but this could be a core tech holding."

Sorry for the length of the following, but I found it difficult to explain my reasoning without going on a bit. Probably means my reasoning isn't very clear ;-).

All in all, if you're going to pay up, I think you're much better off paying up for our old friend AMAT  

I'm almost as shy as you are about the disk drive makers and in the past I haven't really followed any of the stocks closely, with the exception of Iomega and Syquest. The removable drives are somewhat less of a commodity which makes it easier for companies to differentiate their products and thereby improve their margins. The only reason I'm looking at the traditional fixed drive makers now is that it's one of the few sectors which looks cheap at the moment. For that reason, I've rejected EMC. There's no question in my mind that it's a better business than Seagate (at least for now) but you're paying a hefty premium to buy that business. Furthermore, while EMC clearly has advantages in the market place which allow them to charge a premium for their products, I'm not at all confident that they will be able to maintain their superior net margins in the future. First of all, I believe that the highest margins are in proprietary mainframe and midrange DASD, and these markets are not going to grow as fast as the open systems market. And in the open systems market, I believe that EMC is going to start seeing more competition. One of those possible competitors is Seagate, which seems to be launching several initiatives which are targeted at EMC's traditional markets.

All in all, if you're going to pay up, I think you're much better off paying up for our old friend AMAT. Net margins are slightly lower than EMC, but barriers to entry are significantly higher. In fact, when I looked at AMAT and EMC side by side, it struck me that the difference in margins is to some degree due to EMC's lower tax rate. If you compare the net margins and tax rates over the last 5 years, they look like this

         1997         1996        1995          1994         1993
       Net  Tax     Net  Tax     Net  Tax     Net  Tax     Net   Tax
AMAT  12.9% 35.0%  14.9% 35.0%  14.8% 35.0%  12.9% 35.0%   9.2%  33.0%  
EMC   18.6% 25.0%  17.0% 25.7%  19.0% 27.5%  18.2% 29.5%  16.2%  29.2%

  The disk drive business, much like semiconductors, is extremely cyclical and is subject to vicious competition

EMC has done an excellent job of managing their taxes. AMAT, solid citizens that they are, have been paying close to the statutory rate. I suspect that it's only a matter of time before this piece of AMAT's business gets examined and additional profits filter down to the bottom line.

Returning to Seagate, which is definitely cheap right now, the question is whether it represents a good value. There are some serious problems, as there always are when a stock gets beaten up the way this one has. My own feeling is that at this level the only problem we really need to worry about is whether the company will be able to survive. On the one hand, the losses SEG will suffer in the short term are huge. On the other hand, Value Line still has them down for positive cash flow in 1998. The cash position looks good also. If I'm calculating correctly Cash + Short Term Investments - Total Debt = $944.5 Million (about $3.85 per share) as of 12/31/97.

The disk drive business, much like semiconductors, is extremely cyclical and is subject to vicious competition. Capital requirements are also quite high, although not quite as high as for the semi manufacturers. I actually consider the lower capital requirements to be a negative for the disk makers because the lower barrier to entry makes it easier for competition to come on board during the fat times. The saving grace for both the semis and the disk makers is that long term growth has been, and will most likely continue to be, tremendous. If you believe that the growth in future years will be anything like it has in the past, then problems like those being experienced right now should be viewed as an opportunity. If Seagate manages to maintain a strong enough financial position to remain competitive then I don't see how this stock can fail to generate good returns over the next 5-10 years.

This isn't to say that I'm completely convinced yet. The competition Seagate is experiencing is very real, and there's no question that their business is changing dramatically. However this should be nothing new to CEO Alan Shugart, who has time and again demonstrated his ability to survive and prosper during times of turmoil. I'm going to continue reading about the products, looking at the numbers and thinking things over before I make up my mind. But this is one of the very few stocks right now which I consider to be worth that effort.



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