Novice Investing - Seagate Maximizes Maxtor

Date: Monday 01st 2008f December 2008 03:24:33 PM

Seagate Maximizes Maxtor - 12/21/2005

By: Novice Investing Staff

It is a deal. Seagate Technology (STX) announces its intention to buy rival Maxtor Corp. (MXO). Seagate bid $ 1.9 Billion in stock for Maxtor, which represents a 60 % premium. With all these buying frenzy, will rival Western Digital (WDC) get bought? Investors seem to think so, driving its stock price by more than 10 % in early trading.

Let's go back to Seagate's purchase. What is the reasoning behind it? This can be a more strategic reasoning more than anything else. Financial wise, Maxtor has a decent balance sheet with the amount of cash of roughly its long term debt. However, it has been struggling to produce profits over the last several years. It reported a loss for fiscal year 2002 and 2004. On 2003, it reported a profit. So, the only thing consistent for Maxtor is its inconsistency.

60% premium seems huge. While Maxtor share price has been depressed, we believe that if Seagate can wait a while, shareholders might be willing to sell Maxtor at a lesser premium. All right. A deal is a done deal. Management stated that they can wring out $ 300 Million of savings related to the merger. That is about $ 0.52 of savings if we include the dilutive effects of the acquisition. But that is still pretty darn good! No wonder Seagate management is willing to pay a premium. Now, it is a matter of time if they can execute this cost saving goals.

Can they? It is not hard to do. Combined companies have R & D budget of $ 1.0 Billion. While we do not suggest cutting R & D expense to the bone, we believe that they can wring out $ 100 Million savings. In fact, both Seagate and Maxtor has an R& D budget that exceeds its SG&A expense, according to their history. Other savings can be achieved from manufacturing efficiency. Seagate historically has around 20+ % gross profit margin while Maxtor is only half that. If Seagate can bring the Maxtor part of gross margin to 15 % (from the current 10%), then it represents a $ 197 Million of additional profit.

This purchase looks great for both sides. We should applaud Seagate's management for making the move. Still, Western Digital might prove to be a better buy for Seagate. It has a positive net cash of $ 500 Million, as opposed to a positive net cash of $ 0 for Maxtor. Furthermore, Western Digital has been consistently making profits for the last few years.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Seagate Technology (STX) or any other securities.

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