The next 12-36 months should prove to be the sweet spot for mass adoption of Solid State Drives (SSDs). With prices falling below $1/GB even for smaller capacity drives (128-256GB), and performance that can’t be touched by Hard Disk Drives (HDDs), the latter will begin their march into oblivion. But, the migration from HDDs to SSDs is similar to the changeover from dial-up to broadband, and will take time. The rug is getting pulled out from under Seagate
(NASDAQ:STX) and Western Digital
(NASDAQ:WDC) just as they have achieved a certain level of supply/demand/price balance, so no one should expect that the HDD industry (and related stocks) will go down without a fight. The acquisition of STEC
(NASDAQ:STEC) by Western Digital and of Xyratex
(NASDAQ:XRTX) by Seagate, the IPO of Nimble Storage
(NYSE:NMBL), the introduction of helium-filled HDDs and Shingled Magnetic Recording (SMR) are all efforts to fight off the SSD onslaught. Hybrid drives (HDDs with a small SSD on the front end) will likely find some traction among price-sensitive consumers, and helium drives / SMR technology will find a niche in the enterprise market; but ultimately, the HDD business has two major problems: First, it can only compete on price/capacity, and second, HDD companies cannot buy their way into the SSD market unless their SSD target is vertically integrated, i.e. it has a captive source of SSD-quality NAND memory.
The first problem is pretty straightforward: On a per-gigabyte basis, retail prices of HDDs are plunging. Consumers can now buy 2- and 3-TB drives, for the same price that 1TB sold for last year. Few consumers need that much storage size, so holding up the nominal price of a drive by offering more capacity will only go so far. HDD companies need to offer better performance, not just more quantity. Enter the hybrid drives. Western Digital, Seagate, and pure play Nimble Storage have all introduced hybrid products at this point, and I suspect they will get decent traction for a while. Hybrids let manufacturers increase prices and performance by giving consumers a taste of SSD speed, and for many consumers, that will work just fine. But as the per-gigabyte cost of SSDs continues to fall, users will eventually demand the real thing, even if it costs a little bit more. Raise your hand if you would be willing to pay a premium for "instant on" type performance on your laptop or PC. When enough of those hands are up, so will the stop-gap usefulness of a hybrid drive.
On the enterprise and data-center side of the market there is a similar dynamic. The amount of data that needs to be stored is growing at an astounding pace, so capacity is a very important element of enterprise/data-center storage. Price, power efficiency/cost of use, and, of course, performance are also important because data-center margins are getting thin and thinner (just ask Rackspace
(NYSE:RAX), whose operating margins are down to 7%). So helium-filled HDDs and SMR technology will find a market. But here, too, it will be slowly eaten away as SSD arrays drop in price, and demand for ever higher input-output speeds continues to grow. In the end, at the enterprise, data-, and storage-center level non-SSD technologies won't disappear, but they will be relegated to archive-type storage systems where data is written on the disks once and is read/retrieved sporadically.
The second problem -- that is, the challenges that HDD companies will face in buying their way into the SSD market -- is much more difficult, if not insurmountable. There are two key elements to an SSD: the specialized NAND memory and the controller/software that directs the NAND to work as a storage system. In order for SSDs to gain mass adoption, prices must and will come down a lot. But as long as manufacturers can maintain a reasonable gross margin on both the NAND and the software, volumes will make up for the price drops.
Maintaining pricing and differentiation on the software is probably manageable: A company wishing to enter the SSD market can develop the "controller" know-how in house or, as in the case of Avago's
(NASDAQ:AVGO) buyout of LSI Corp.
(NASDAQ:LSI), it can be acquired. The NAND aspect is not manageable. The barriers to entering the manufacturing of SSD-quality NAND are very high, and the intellectual property that goes into the specs for that kind of NAND is no cakewalk either. If you want to sell SSDs -- particularly into the enterprise/data-center market -- obtaining the NAND for your drives from some back-alley/white label NAND foundry just won't cut it. Currently there are four main players in the high performance NAND game -- Samsung
(NASDAQ:MU), and SanDisk
(NASDAQ:SNDK) -- and they all have very solid SSD operations. It is hard to envision a scenario where an SSD manufacturer can source the NAND from one of those four companies and, at the same time, compete against them for the finished product on a price basis. Fusion-io
(NYSE:FIO) tried that, and despite two huge cutting-edge customers -- Facebook
(NASDAQ:FB) and Apple
(NASDAQ:AAPL) -- its business model is in total shambles. Similarly, it remains to be seen if Western Digital will make any significant money off of its hybrid-drives partnership with SanDisk.
To recap, my sense is that three years from now Seagate and Western Digital outsized gross margins (their GM are running some 50% above the longtime average, and when things turn sour in this business you see way more than just reversion to the mean) will be a long lost dream and their stock charts will look very different. But...
shorting them aggressively will require patience and deep pockets. Right now these companies throw off a lot of free cash flow; add to it their ability to sell bonds to buy back stock, and they will be able to engineer stable if not higher stock prices for a while. I’ve made no secret of my favorable bias for SanDisk. The story I’ve been outlining for the last three years has played out almost perfectly (see here
or search the archives for many more articles and Buzz & Banter
posts), and 2014 should be the beginning of the sweet spot for its business. Net-net, at least for the next 12-18 months, I think it will be a lot easier to be long the SSD names than to be short the disk-drive makers.
A happy and healthy New Year to all readers, and continued good trading!
Positions in SNDK, AAPL
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