They won’t buy Seagate, but I won’t sell it

November 30, 2010

It appears that Seagate (STX) will not be taken over after all, as it has rebuffed its
buyers for not meeting their price. The stock price seems to have taken this
development in stride, dropoping only 3.25% today. However, the market’s incurable
impatience had already caused the price to drift down from the $15 level it had
reached after the buyout was announced. But the question remains of what to do now.

It would not surprise me if the price fell even lower, particularly as there seems to
be a gloomy sentiment hanging over the market. Actually, Seagate is headquartered in
Ireland, which doesn’t seem to have entered the public’s consideration but one never
how the investing public’s mind will choose to connect the dots in future. At any
rate, I do not feel that this event is a setback, as my investment thesis for Seagate
never centered on its being a buying candidate. I simply identified a company with a
free cash flow yield of about $1 billion per share, with an extra billion in cash on
the books, selling for what was at the time about $5 and a quarter billion.

At this time, the first quarter 2011 cash flows were below the historical trends, as
capital investments and operating expenses were both higher than the historical
results. I do not feel that a single quarter’s results affect the analysis that much,
but I think some monitoring of the situation is in order. But leaving that aside, the
company is still selling for $6.34 billion, which is a P/E ratio of 6.3. And, as
their levels of cash on hand are roughly $1 billion over their historical level, the
prospective yield is even higher.

On the other hand, the market seems to have decided that solid state drives are the
wave of the future and that anything that is not solid state is doomed. Of course,
Seagate has some solid state products. Moreover, it seems to be the trend of all
storage devices to inevitably become cheaper, so it may be that a conservative
earnings multiple would be lower than for most companies. Even so, I think that six
is too low for one of the two leaders in the hard drive industry.

The firm did announce a $2 billion share buyback, presumably in order to soften the
blow. As the stock is apparently underpriced, it is probably as well for the company
to buy back shares while they are cheap. Even so, I think of share buybacks as a lazy
step for management, who can think of nothing to invest their money in but who for
whatever reason are unwilling to commit to a dividend. Still, the high and fairly
stable cash flows of Seagate are attractive to me, and I am definitely not going to
sell based on this announcement.

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