Thesis

Seagate Technology Holdings plc (NASDAQ:STX) is at the forefront of the market for solving mass-capacity storage problems. With breakthrough technologies, its product portfolio consists of storage devices, systems, and services from edge to cloud for OEMs, distributors, retailers, and institutions. As of 04/12/24, STX’s stock price was $85.19. Recently, Seagate provided forward guidance stating that its new Mozaic platform will undergo volume scaling. In response, I believe its Mozaic platform will strengthen and grow Seagate’s position in the mass capacity storage industry, which will boost revenues. Furthermore, I believe Seagate’s revenues will increase due to a refresh in its business cycle as companies replace or upgrade their storage systems. Ultimately, this cycle refresh will signify Seagate and its customers are overcoming economic constraints that occurred during the pandemic and a higher interest rate environment.

Catalysts

Revenue Contributions from Mozaic 3+ fueled by HAMR Technology

What is Heat Assisted Magnetic Recording (HAMR) technology? HAMR technology is the next paradigm to mass capacity storage, as its predecessor Perpendicular Magnetic Recording+ (PMR+) reaches its limit for aerial density. Eventually, HAMR will overcome PMR+ because it writes data at high temperatures, which makes it easier to process and increases aerial density.

In response, I observed Seagate to be at the forefront of the mass data storage market because it is the first to release 32 TB HAMR technology-backed storage devices and platters with 3 TB capacity. Seagate’s release of these capabilities has several benefits for its business:

Firstly, it will increase Seagate’s operating margins. HAMR technology doesn’t require increased platters or heads to achieve higher aerial density, unlike standard PMR technology. This refers to a higher number of bits per square inch of storage space. Therefore, HAMR technology decreases Seagate’s overall cost of goods sold by enabling fewer materials bought for a lower ratio of terabytes manufactured per dollar spent. This will create higher margins for Seagate.

Secondly, HAMR technology addresses major concerns data centers encounter regarding operating costs. Fortunately, according to Seagate’s commentary, HAMR technology will decrease these costs, power, and space. I believe these cost savings for consumers will inevitably increase Seagate’s revenues because its HAMR technology is the first to market.

Thirdly, a boost in revenues is already apparent. Seagate plans to ship one million of its 32 TB HAMR-backed storage devices by the first half of 2024 and receive international qualification for its drives. Qualification, in this sense, means that its drives have been tested, proven, and received well by its customers. The projected revenue increase from the initial distribution, according to Barclays Analyst William Levy, is $300M.

Fourthly, there is an increase in data storage demand due to artificial intelligence and the dominant integration of IoT into society. Data storage capacity is projected to grow from 10.1 ZB to 21.0 ZB from 2023 to 2027 respectively, which is a CAGR of 18.5%. This demand for storage capacity will benefit Seagate.

I also believe Seagate will obtain a first-mover advantage and become a solidified market leader for mass storage capabilities, which are in high demand. Seagate will have advantages to early market share, higher margins, strong brand recognition, and economies of scale, which aid in outpacing its competitors. Its move to launch its HAMR-backed HDD will be responsible for its increased revenue growth in the future.

To elaborate my view on first-mover advantage, I view Seagate’s strategic decision to launch HAMR to be comparable to Apple’s 2007 iPhone launch. Similarly, Apple revolutionized the mobile phone market and the first competitor was Android, which followed in 2008. Though Apple’s iOS and Android have similar operating systems, Apple’s iOS loyalty rate is at 90% while the closest Android competitor, Samsung, has under 70%. Apple remained the first, the original, and preferred smartphone in the U.S. market, which I view as relatable to predicting Seagate’s future market position, as Seagate will continue to innovate its 32 TB HAMR HDDs on 18 to 20-month cycles with a sequence of 32 TB, 36 TB, 40 TB, and 50 TB.

Periodic Replacement or Upgrading of Existing Units

The enterprise storage drive industry is cyclical and is exposed to troughs and peaks, as it experiences cycles of consumers replacing or upgrading existing technologies. This is because these technologies are depreciated across five to seven years and consumers have to replace or upgrade their data storage technologies.

In response, I believe the next demand cycle is on the horizon. My beliefs are based on analyzing the total shipments for enterprise storage drives, which have declined in the last four years. From 2020 to 2024 exabyte shipments fell 33%. This is revealed in Graph 2. Furthermore, Graph 2 also reveals an exponential increase in exabytes shipped from 2024 to 2028.

I found there are two vital trends that contribute to this projection. One, in 2018, digital information was tracked, and it was revealed that it doubled every two years. Second, in response to digital information growth, I believe the projected exabyte shipments will be fueled by data storage capacity growing at a CAGR of 18.5% from 2023 to 2027.

These requirements for the cloud and big data are enabled by improved connectivity, faster computers, artificial intelligence, and overall IoT, strengthening Seagate’s sales and positioning the company to take advantage of the upcoming cycle, as it just began shipping its market-leading 32 TB HAMR HDD.

Seagate Gross Margin Historicals and Projection

Seagate’s gross margins have been decreasing since 2021, and it has been fighting to return to historical 30% sustainable levels. The historical gross margin of Seagate is in Graph 3. The sharp decline to 18.70% gross margin was not normal compared to its historical data. The only time Seagate exhibited similar low gross margins, in the last 14 years, was in 2011. After a decade of operational expertise and stronger supplier relationships, the recent low gross margins make me conclude the data to be an outlier.

I view the fall in gross margin to be attributed to external factors such as recent supply chain disruptions and higher inflation eating into its margins. However, companies have rebuilt decade-old sourcing and logistic supply chains due to the disruptions during the pandemic. These optimizations have aided companies in tackling the geopolitics that threaten the global supply chain today. Furthermore, inflation has fallen from 7% to 3.5% from 2021 to today, so I believe Seagate will reach normalized and sustainable 30% gross profit margins.

Seagate’s gross profit margin is important to its profitability because a 1% fall in gross margin, in FY 2018, implied a 2% downside in short-term valuation. This was estimated through a margin analysis, and it determined Seagate’s sensitivity to gross margin changes. The analysis determined how gross margin will impact gross profit, which will then impact EPS and correspondingly impact the valuation. Graph 4 reveals that a 1% change in gross margin decreased gross profit by $108M in 2018.

Therefore, as we experience fewer supply chain disruptions and lower inflation, Seagate deserves a higher valuation due to its projected return to sustainable 30% gross margin levels. Additionally, in 2024 and onwards, Seagate’s gross margin will be increased through the cost savings exhibited through HAMR.

Valuation

Revenue Growth Rate Projections

In my DCF model, I estimated a revenue growth rate of 5.00%, 10.00%, 29.00%, 29.00%, and 29.00% in 2024, 2025, 2026, 2027, and 2028 respectively. There are several reasons for this:

Firstly, Seagate’s revenue fell significantly from $10.5 billion to $7.4 billion in 2023 due to lower HDD demand. Throughout 2020 to 2023, there have been unfavorable macroeconomic conditions, which sustained a longer down cycle according to the CEO of Seagate Dave Mosley. As Mosley continued to relay information, there were mentions of weak demand in China, but pointed towards an HDD demand uptick in certain markets.

Therefore, as businesses begin to prepare for an economy with lower interest rates and higher economic activity, I believe they will spend according to pre-pandemic levels. Therefore, my view is that Seagate will receive more market share through its HAMR technology and demand from companies as IT capital expenditures increase, which will include mass capacity storage.

Secondly, my revenue projections are also defended by the catalysts I mentioned above. To list them, it relates to Seagate’s competitive positioning, HAMR launch, increasing gross margins, data center storage capacity growth, the enterprise storage drive cycle refresh, and artificial intelligence CAGR.

Terminal Value Projections

I then assumed an EBITDA multiple of 15x, which is on par with the comparable analysis I ran. My comp set included Hewlett Packard, NetApp, IBM, Dell Technologies, Toshiba, and Western Digital Corporation, which is demonstrated in Graph 5. Toshiba and Western Digital Corporation were dropped from the comparable analysis due to Toshiba having a current TEV/EBITDA close to 0 and Western Digital Corporation having a negative current TEV/EBITDA. I concluded Seagate’s EBITDA multiple is 15x because the company has the highest market share at 44%, strong historical gross margins, strong revenue growth, and market-leading patents for HAMR technology.

Weighted Average Cost of Capital (WACC)

To calculate WACC, I first divided the interest expenses from long-term debt and capital leases; I then multiplied by the weightage of debt to find a 5.87% Weighted Cost of Debt. I exercised a similar process to solve for the Cost of Equity, where the 30-year treasury bond is the risk-free rate, the SPY historical average return is the market return, and I used Seagate’s beta of 1.07. After multiplying by the Weightage of Equity, I arrived at a 10.27% Weighted Cost of Equity. Lastly, I used the weight of debt and equity to get a WACC of 8.90%.

Intrinsic Value

To find the intrinsic value, I summed the five years of discounted future cash flows and discounted terminal value to find the enterprise value. Then I subtracted net debt from enterprise value. After dividing by the total shares outstanding, I presented the target price of $123 per share, representing a 44.38% potential upside.

Risks

Unfulfilled HAMR HDD Qualification

Seagate has plans to ship one million of its 32 TB HAMR HDDs in the first half of 2024. There are rumors that a bulk order has already been placed by Google, but they are still only rumors. Furthermore, the next hurdle to ramping up HAMR delivery volume would be international qualification from key consumers. The product must be well received by the consumer.

I acknowledge the risk that its new HDD may not be integrated on a mass scale and understand this could dampen future projections. However, I believe the research and development that went into developing the 32 TB HAMR drive stems from Seagate’s cross-product synergies, so I remain to view HAMR as a market-ready product that will be well received due to Seagate’s track record.

Interest Rate Hikes or a Drawn Out Sustained Higher for Longer Policy

Recently, the rate cut in June 2024 has been revised to have less than 20% probability as inflation remains to be stricter than expected. Furthermore, the topic of interest rates has begun to shift to persistent high interest rates for longer periods and fears of a possible rate hike. In either scenario, I acknowledge the risks posed by the macroeconomy. Seagate has typically not performed strongly in restrained economies with less ability to scale as demand falls and price control weakens.

However, I view the FED’s responsibility to control the government’s inflated debt due to higher interest rates, an upcoming election, and no wage increases to be strong indicators that the FED is very cautious. I believe the FED is aware high interest rates for extended periods are also unsustainable. Therefore, I believe it will only take a few combinations of positive data to stay on track for rate cuts in the latter half of 2024 or early 2025.

Conclusion

I would like to conclude this report with a Buy Recommendation for Seagate Technology Holdings PLC stock with a target price of $123 and a 44.38% upside. I believe Seagate is a market leader within this industry and it maintains a 44% market share. Its revenue will be supported by catalysts that highlight the demand for its products. The catalysts will follow growth trends in the data storage sector, artificial intelligence sector, HDD HAMR sector, and increasing growth margins. Therefore, I do not suspect Seagate to lose its intrinsic value I projected.