Seagate Technology plc (STX) announced the signing of a definitive agreement with Samsung Electronic Co. Ltd. to extend their strategic ties. The agreement encompasses various issues, expected to be beneficial for both companies, going forward. The deal was announced in conjunction with the third quarter results.
Under the terms of the agreement, Seagate will acquire Samsung’s Hard Disk Drive (HDD) business unit. Seagate will pay a handsome $ 1.375 billion, 50% in cash and 50% in the company’s shares. This translates to $ 687.5 million in cash and $ 687.5 million worth of roughly 45.2 million shares; approximately 9.6% ownership interest in Seagate. Moreover, Samsung will also have the opportunity to designate one member to Seagate’s board of directors.
Apart from this, Seagate and Samsung extended their existing patent cross-licenses, entered into a NAND flash agreement and a disk drive supplier agreement for Samsung PCs and consumer electronics, also agreeing to co-develop enterprise storage solutions. Seagate expects that the strategic agreements to significantly expand its customer access in China and Southeast Asia.
The HDD business acquisition is subject to regulatory approval, and Seagate expects to wrap up the deal by the end of the year. Management expects the acquisition to be accretive to its business within its first full year of operation. By taking over only the HDD business of Samsung, Seagate will be able to minimize integration risks and avoid restructuring, driving accretion sooner. The combined entity will allow Seagate to increase its scale and operate more efficiently.
The disk drive market is highly competitive, and has experienced drastic pricing pressure due to supply/demand volatility. HDD supply is driven by prisoner's dilemma-style game theory, which can lead to oversupply situations, aggressive pricing and detrimental margins.
In the near future, hard disk companies might be vulnerable to pressures as customers such as tablet PC makers choose flash cards for storage purposes instead of the customary hard disks.
The situation may compel companies to cut hard disk prices , which may in turn hurt margins. In such a situation, companies can go in for acquisitions to further consolidate the market and alleviate competition. Seagate’s rival Western Digital Corporation (WDC) recently safeguarded its position with the acquisition of Hitachi Ltd.'s (HIT) HDD business. We believe that the Samsung deal will strengthen Seagate’s position, which could lead to more stable pricing for the industry, thereby driving more profitability for storage players.
Seagate’s third quarter results were disappointing, mainly due to lower shipments. Additionally, the fear of near-term volatility due to Japan issues forced the company to provide a weak guidance for the fourth quarter. While the company’s decision to buy back shares and pay out dividend could be seen favorably by income-seeking investors, weakness in the consumer segment, price erosion, rising demand for flash drives and competitive pressure from Western Digital Corporation keep us on the sidelines.
Currently, Seagate has a Zacks #3 Rank implying a short-term Hold recommendation.
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