Seagate deal reflects storage industry's idiosyncracies

Hundreds of millions of hard disks leave factories every year. These data storage units sit inside every desktop computer and most servers and are an essential element for the increasingly important storage-specific products sold by EMC, Network Appliance, IBM, Sun Microsystems, Hewlett-Packard and others. But the rising importance of disk technology hasn't meant rising profits.

"It's been a topsy-turvy world

Seagate today was bought in a complex deal that will turn over its hard disk, tape drive and other storage operations to a group of investors, while the rest of the company's assets go to software developer Veritas. Under the transaction, Seagate's storage business will change from a publicly held company to a private entity. (See related story)

The unusual deal is a fitting installment in the company's roller-coaster history, which has been influenced by its founder and former chief executive, Al Shugart, who was ousted by the Seagate board in July 1998.

Seagate is one of Silicon Valley's oldest companies. Founded in 1979 by Shugart and others, the Scotts Valley, Calif., firm became one of the key suppliers of hard drives for IBM PCs and quickly exploited its pioneer status to land contracts with several other PC makers. Despite a near-permanent price war, Seagate has remained in the top ranks of disk drive makers.

For years, the company's identity was shaped by the cantankerous Shugart. In a business populated by futurists and visionaries, Shugart came across as a meat-and-potatoes kind of guy out to deflate some of the pomposity surrounding technology.

Hawaiian shirts were his signature outfit, and he often was seen with a Marlboro Light in hand. In recent years, he ran his dog for Congress and sponsored a California ballot initiative that would allow citizens to vote for "none of the above."

After financial losses in 1998, Seagate asked Shugart to resign and took a charge of $8 million to $10 million to cover severance costs, according to SEC documents filed at the time.

Dataquest's Monroe had mourned the loss. "It's sad (and a measure of the mercilessness of Silicon Valley) to see a man of Shugart's stature being forced out of the company he founded," Monroe wrote. "His name is nearly synonymous with disk drives, and his career has been made of the stuff of legends...To the best of Dataquest's knowledge, no other Silicon Valley executive can stake a claim to such an extensive and influential tenure."

Shugart contemplated going into some form of public relations consulting after leaving Seagate but instead formed a venture capital group, Al Shugart International.

Some suggest that consolidation is the cure for the hard disk industry's woes. Fewer suppliers would mean more moderate competition and therefore higher profit margins, the argument goes. Not so, argues Monroe. Even with consolidation, consistent profits will remain tough to find.

First of all, supply and demand has been pretty well matched since the industry recovered from an unpleasant surplus in 1997. Second, consolidation has been proceeding rapidly.

In 1988, 62 companies sold 15.8 million hard disks, according to Dataquest's statistics. In 1993, the number of suppliers dropped to 22, but unit shipments rose to more than 50 million. In 1999, there were just 10 major suppliers that sold 174 million drives.

So why have revenues been weak despite the growing business? Essentially, disk makers have charged less and less per megabyte of storage capacity.

Statistics posted late last year from a study by Disk/Trend, a marketing analysis firm, bear out the harsh realities of the disk drive business. In 1998, revenues for the industry as a whole declined by 5.2 percent, although the number of units increased. Revenues grew in 1999 by an estimated 7.7 percent to about $32 billion, but revenue growth didn't keep up with unit growth of 16.1 percent.

"In 1988, the average price per megabyte for all hard disk drives was $11.54. In 1998, the average price had fallen to 4.3 cents, and the estimate for 1999 is 2.3 cents. By 2002, the overall average price per megabyte for all disk drives is projected to be 0.3 cents," the Desk/Trend study said.

To compensate, storage companies have been scrambling to expand into more profitable businesses than just selling hard drives. Typically, they have gone into selling storage software and special-purpose servers.

The strategy is no surprise. EMC is perhaps the best example of a company that makes a tidy profit by assembling disk drives in a fancy container with technical support and high-powered software.

A megabyte of EMC storage costs $20; a megabyte of Seagate storage costs a penny. "Where do you want to be on that value chain?" asked Monroe.

"It's a ferociously competitive industry, full of brilliant people, and it's somewhat unfortunate we haven't figured out a way to make more money," Monroe said. "There is no room for comfort at any level."

Despite the hardships, investors in a privately held Seagate should profit.

"Investors will make out well," said Paul Fox, an analyst with Banc of America Securities.

And despite Seagate's transformation into a private company, Fox said the company should not have trouble accessing capital if needed.