Tickers in this Article: STX, WDC, INTC, MU, HPQ, DELL, EMC
When I last wrote on Seagate (Nasdaq:STX), I said that the huge uncertainties surrounding the hard disk drive market were going to make this an interesting, albeit unpredictable, stock. For most of the last quarter, though, the stock has chopped between $26 and $28 as the bulls and bears battle it out over how quickly hard drive prices will normalize and what normal even means anymore.

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Another Surprisingly Good Quarter
Although Seagate's top-line outperformance was relatively light; the company's margins trounced expectations and fueled a much better per-share number.



Revenue rose 65% from last year and 39% from the prior quarter on a 25%/29% increase in units shipped. Significantly, it looks like there is many expected PC sales on the way as enterprise market growth (storage, mainly) was flat year-on-year (but up 15% sequentially). ASPs were also quite good - rising 33% from the year-ago level and dropping just 1% sequentially.

Margins were the real highlight. Gross margin improved by more than five points sequentially and nearly 18 points from last year. While Seagate continues to spend on R&D, core SG&A expenses seemed to drop as well.

SEE: Understanding The Income Statement

The ASP Mystery
The big driver for Seagate over the next few quarters is going to be how quickly hard drive prices normalize as production levels come back after the serious Thai flooding. While ASPs hovered around the $50s prior to the flooding, they spiked as high as $150 afterward. Now they're settling back down, but still seem to be in the mid-$70s.



The question I have is whether consolidation that started before the flooding is going to create any sort of "new normal." Western Digital (NYSE:WDC) bought Hitachi's business and Seagate bought Samsung's, further concentrating the market. It would seem that as the market gets closer to a duopoly, mutually destructive price-based competition would be counter-intuitive.



That said, there are other realities influencing pricing. If HDD pricing doesn't fall, will big buyers like Hewlett Packard (NYSE:HPQ), Dell (Nasdaq:DELL) or Lenovo see even more of a shift to solid state drives (SSD)? After all, NAND pricing keeps dropping and companies like Micron (Nasdaq:MU) and Intel (Nasdaq:INTC) have repeatedly said that they're seeing more and more interest in SSDs and adopting them.

SEE: Earning Forecasts: A Primer

The Bottom Line
Even if alternatives like PC/notebook SSDs, smartphones and tablets challenge the computer business, enterprise demand is likely to continue to increase as EMC (NYSE:EMC) and NetApp (Nasdaq:NTAP) keep shipping storage systems to support Big Data.

That said, it looks like the question of obsolescence for HDDs is a when, not if, question. That makes Seagate a very tricky stock to value today. I suspect that while Seagate will see a spike in near-term free cash flow, the next decade is going to see significant erosion.



The market already seems to be pricing in a steep cliff in Seagate free cash flow, and a longer period of firm ASPs and/or increased efficiency (better margins) could stretch out that time to the edge of the cliff. That being the case, this could still be a very interesting stock to own for 2012, but I don't think it would work out well as a long-term holding.

SEE: 5 Must-Have Metrics For Value Investors

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.


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