Seagate Goes Hybrid

The long-term prospects of hard disk drive titans Seagate and Western Digital have not looked good. In a recent article, I argued the logic of being bullish on this industry if personal computers are indeed beginning to die. It stands to reason that HDD manufacturers such as Seagate should perish as well. But Seagate has other ideas.

Can hybrids improve the economics of storage?
The company has introduced its third-generation SSHD, or solid state hybrid drives: the Seagate Laptop SSHD, 7 mm-high Seagate Laptop Thin SSHD, and the Seagate Desktop SSHD. I think this is a smart move by Seagate, especially since Apple recently announced its Fusion Drive, which is said to boot much faster while offering better read/write performance.

Scott Horn, Seagate's vice president of marketing, describes them this way:

Even though Apple has not used the term "hybrid" to describe Fusion, the word is being used by writers and analysts in their descriptions. So if Seagate and Western Digital, which began shipping its own hybrids in January, are moving into the SSHD platform to support new industry standards from (among others) Apple, then it's good idea. But how well will this work? More specifically, can hybrids change the economics of the desktop storage business?

That's the question investors must first answer, which was the thesis of my previous sell recommendation. While Seagate has been able to fight the increased adoption of solid state drives, or SSDs, the company now understands that it can't fight the rise of mobile devices infinitely. Essentially, evolve or die. But these hybrids look more like a "gap-closing" solution than anything "game-changing." And Horn's description of "adding a turbo-charge to your PC" sounds familiar.

Yes, yes, very impressive, but...
While the features boast tons of speed and performance, there's a part of me than thinks... so what! As groundbreaking as these new SSHD drives might be, they are still just internal components of an industry that's in decay. But Seagate is not the first to attempt "the next big thing in PC." It's a good idea, but investors have to prepare for a possible thud if expectations become too unrealistic.

There's still a bigger issue at hand. Intel has not been able to excite consumers with new/faster PC chips. Even though they have consistently improved over the years, the company has still posted year-over-year declines in chip revenue the past three quarters. Likewise, even though Microsoft's new Windows 8 operating system was a step in the right direction, the adoption among consumers have been far below the company's expectations.

Plus, a case can be made that Microsoft's soft Windows 8 sales have translated to year-over-year PC revenue declines from Dell, which has packed its bags to regroup. Likewise, although Hewlett-Packard's new line of ultrabooks are improved, Windows 8 did very little to revitalize sales. Consequently, HP's still stuck trying to reinvent itself. In other words, the PC death effect is real. So it's not exactly reassuring to hear Seagate describe its hybrids as turbo-charged PCs.

How long can this transition last?
I'm not certain that producing new hybrid drives is enough to get investors excited. It gets the job done from the standpoint that it's an important intermediate step, but that's as much credit I'm willing to give. Granted, personal computers are not going to vanish overnight. But it's no longer a growth business, either. And Seagate's second-quarter results revealed some underlying weaknesses.

Average selling prices, or ASPs, fell 7% year over year and 3% sequentially. ASPs also hurt profitability as the company struggled with product mix. And even though margins arrived in line with estimates, they weren't very strong. The company posted 4% year-over-year drop in gross margin, while shedding 1.5% sequentially. Similarly, there was a 8% decline in operating income, which fell 13% from the first quarter. It's stillunclear how Seagate is going to sustain this transition without near-term changes to the business model.

What of the stock?
The stock is cheap, but there's no compelling reason to buy here. While the fundamentals are indeed solid, the long-term risks are still there. And placing a bet here assumes that there will be a reversal of fortune at some point. And investors have to decide how much time this company has.

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The article Seagate Goes Hybrid originally appeared on Fool.com.

Fool contributor Richard Saintvilus owns shares of Apple. The Motley Fool recommends Apple and Intel. The Motley Fool owns shares of Apple, Intel, Microsoft, and Western Digital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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