Western Digital designs, develops, manufactures and markets hard disk drives.The company’s hard disk drives are used in desktop personal computers (PCs), enterprise servers, network attached storage devices; consumer electronics products such as video game consoles, personal/digital video recorders, and satellite and cable set-top boxes; and as external storage devices. The company’s improving financial performance in the last few years has enabled it to strengthen investor confidence. However, intense competition would lower the prices and affects the profitability and market share of the company.
Strong financial performance
Western digital has recorded strong financial performance over the past few years. The company’s total revenue has grown at a compounded annual growth rate of 19% to reach $5,468 million in fiscal 2007 from $2,719 million in fiscal 2003. Western Digital’s operating income increased from $187 million in fiscal 2003 to $415 million in fiscal 2007, representing a CAGR of 22%.The company’s net income increased from $182 million in fiscal 2003 to $564 million in fiscal 2007, growing at a CAGR of 33%.Western Digital recorded better operating and net income margins over its competitors. In fiscal 2007, the company recorded operating and net income margin of 7.6% and 10.3%. In the same fiscal year, Toshiba, a competitor of the company recorded operating and net income margin of 3.6% and 2.2%. Similarly, Fujitsu, another competitor of the company, recorded operating and net income margin of 3.6% and 2.3% in fiscal 2007.
The company’s cash from operating activities has increased from $101 million in fiscal 2003 to $402 million in fiscal 2007, representing a CAGR of 41% for the five year period. Western Digital has also recorded comparatively higher returns than its competitors. In fiscal 2007, the company recorded return on assets (ROA), return on equity (ROE), and return on capital employed of 22.6%, 39.3%, and 23.4%, respectively. For the same fiscal year, Toshiba and Fujitsu recorded ROA, ROE, ROC of 2.6%, 13%, and 8.3% and 2.6%, 10.9%, and 8.5%, respectively. Strong revenue growth and cash flows indicate better financial position, and helps the company build investor confidence.
Broad product portfolio
Western Digital is a provider of hard drives for various markets like desktop, mobile, enterprise, and consumer electronics.The company’s offerings for the desktop users include popular drives like WD Caviar 7,200 RPM drives, available in both EIDE and Serial ATA (SATA) interfaces. 10,000 RPM WD Raptor X is the only hard drive in the world that has a see-through window. WD Scorpio hard drives form the high performance drives in the mobile line.
In the enterprise storage segment, Western Digital offers WD Raptor, the world’s only 10,000-RPM SATA hard drives. The WD RE enterprise series and WD Raptor offer high performance, reliability and capacity for network attached storage devices, storage area networks, workstations, medical imaging, gaming and video/broadcast applications. In the consumer electronics devices, Western Digital products include video-streaming drives catering to the users of digital video recorders requiring large capacity for video streaming of TV shows and movies. Broad product portfolio provides cross selling opportunities and insulates the company from decline in demand in any particular segment.
Western Digital generates significant amounts of revenues from a limited number of customers. In the fiscal 2007, the company generated more than 10% of its total revenues from Dell, its single largest customer. During 2007, 2006 and 2005, Dell accounted for 10%, 12%, and 16%, respectively, of the company’s total revenue. In fiscal 2007, Western Digital recorded 47% of its total revenues from top 10 customers.
Dependence on limited number of customers for large proportion of its revenues increases the business risk of the company. Loss of significant customers would not only affect the company’s results of operation but also its market share.
Declining research and development (R&D) investment
The R&D investments of Western Digital have been declining over the past few years. Though the company’s investment in R&D in absolute terms has increased from $135 million in fiscal 2003 to $306 million in fiscal 2007, its R&D spend as a percentage of total revenues has declined from 6.6% in 2004 to 5.6% in fiscal 2007. By contrast, Seagate, a competitor of the company spent 8.7% of the total revenue as R&D investment. Toshiba, another competitor of the company has recorded slightly higher investments of around 6% of the total revenues as R&D spend.
Declining investment in R&D indicates lower attention towards development of technology and new products, which is likely to have an adverse impact on the future competitiveness of the company. Lack of competitiveness would adversely affect the business operation and market share of Western Digital.
Weak internal controls
The company’s involvement in certain litigations indicates instances of weak internal controls. In fiscal 2006, the company initiated a review of historical stock option grants, which brought out several derivative actions file on behalf of the company. These actions were against certain current and former directors and executives of the company with the company as a nominal defendant. These actions claim violation of certain sections like 10(b), 14(a) and 20(a) of the Securities Exchange Act, accounting, breach of fiduciary duty and/or aiding and abetting, constructive fraud, waste of corporate assets, unjust enrichment, rescission, breach of contract, violation of the California Corporations Code, abuse of control, gross mismanagement, and constructive trust in connection with the company’s option granting practices.These complaints seek monetary damages and reforms to the company’s governance.Weak internal controls would affect the investor confidence on the company.
Western Digital has made a significant acquisition in the recent period. The company acquired Komag, a manufacturer of hard drives, in September 2007. The company has strategic intention of integrating its research and development activities in the US and its manufacturing facilities in Malaysia and Thailand with those of its new partner, creating an improved value chain and cost effective model.Through the acquisition of Komag, the company is also planning to integrate media in the hard drives. Successful integration of the acquisition would enable the company create effective supply chain and strengthen its revenue streams.
Western Digital is planning to expand its facilities in the US. In October 2007, the company signed a multi-year lease for its planned hard drive design center in Longmont, Colorado. The company is working towards making the center operational. Through the new facility, the company is planning to ensure continued growth in its engineering capabilities. Expanding design centers enables the company to focus more on the new technologies and enhance its product offerings.
Western Digital has launched several new products in the recent period. In November 2007, the company announced its new environmentally friendly, GreenPower family of WD enterprise hard drive products. The WD RE2 GreenPower (GP) hard drive is in capacities of 500 gigabytes (GB),
750 GB and one terabyte (TB), and provides cost savings to the organizations dealing with large data. This new drive caters to the information technology challenges like total available drive slots, maximum capacity, and available power and budget. These products have power saving as their primary focus and deliver 40% savings in hard drive power consumption.
In September 2007, the company launched My Book, external storage solutions to suite specific users. These solutions were made available in My Book Home, My Book Office, and My Book Essential Editions in capacities ranging from 320 GB to 1 TB. Earlier the company has released MY Book storage appliances in capacities of 2TB in view of increasing digital content. New products launches would provide the company with opportunities to add new customers and enhance its market share.
Western Digital operates in intensely competitive technology equipment markets. In the hard drive industry, suppliers compete for sale of HDDs to limited number of large customers. Most of the products in the industry are highly substitutable as they are used in compliance with certain technical standards. High substitutability poses difficulties in product differentiation.
Hard drive manufacturers compete on the basis of product quality, reliability, storage capacity, unit price, product performance, production volume capabilities, delivery capability, leadership in time-to-market, time-to-volume and time-to-quality, and service and support.The company’s products are differentiated based on operational excellence, high product quality and reliability, and designing and incorporating into hard drives desirable product performance attributes rather than on storage capacity, buffer size or time-to-market.
Some of the hard drive manufacturers with whom the company competes include ExcelStor Technology, Samsung Electronics Incorporated, Fujitsu Limited, Seagate Technology, Hitachi Global Storage Technologies, and Toshiba Corporation. Increasing competition lowers the prices and affects the profitability and market share of the company.
Declining average selling prices
The hard drive industry has been experiencing declining average selling prices over the past few years. Prices of the hard drives are increasing owing to various factors like decreasing production costs,liquidation of excess inventories and attempts to gain market share. Average selling prices (ASP) also decline when there is a shift in the mix of product sales, and sales of lower priced products increase relative to those of higher priced products. Continued decline in the industry ASPs would lead to the same in the company’s ASPs, affecting its operating profits.
Western Digital is dependent on numerous copyrights, trademarks, patents and related commitments to protect its intellectual property rights. In spite of the careful procedures and ownership of several US and international patents, the company is involved in intellectual property related litigations. For instance in January 2007, Texas based StorMedia filed a complaint against the company and several other drive manufacturers alleging infringement of a patent (US Patent No. 6,805,891). Western Digital answered the complaint denying allegations and asserting affirmative defenses, and has also filed counterclaims against StorMedia. Such litigations would impose financial obligations on the company. Any unfavorable outcomes in the patent related litigations claiming damages would adversely affect the reputation and financial position of the company.