Monday, June 6, 2011

Commentary: HDD market consolidates as players keep their eyes on the cloud

The year 2011 has been a volatile one for the hard drive disk (HDD) industry. With Western Digital having bought Hitachi Global Storage Technologies (HGST) for US$4.3 billion and Seagate acquiring Samsung Electronics' hard drive department for US$1.375 billion, the industry is now left with three major players. Moreover, Japan's earthquake in March impacted the production capacity of upstream material suppliers such as TDK and Texas Instruments (TI), leading to disruption in the plans of NAND flash memory chip makers who are hoping to grab the storage component market opportunity created by mobile devices such as tablet PCs and smartphones. During this volatile period, HDD makers are striving to position themselves better in the market.

The year 2011 has been a volatile one for the hard drive disk (HDD) industry. With Western Digital having bought Hitachi Global Storage Technologies (HGST) for US$4.3 billion and Seagate acquiring Samsung Electronics' hard drive department for US$1.375 billion, the industry is now left with three major players. Moreover, Japan's earthquake in March impacted the production capacity of upstream material suppliers such as TDK and Texas Instruments (TI), leading to disruption in the plans of NAND flash memory chip makers who are hoping to grab the storage component market opportunity created by mobile devices such as tablet PCs and smartphones. During this volatile period, HDD makers are striving to position themselves better in the market.

HDD industry to see continued consolidation

Since the start of 2011, the HDD industry has seen several mergers. On March 7, Western Digital bought Hitachi Global Storage Technologies for US$4.3 billion, and on April 19, Seagate surprised much of the market by announcing it would buy Samsung Electronics' hard drive department for US$1.375 billion (US$ 687.5 million cash plus 9.6% of equities). The industry is now dominated by three major players. Since Fujitsu sold its hard drive business to Toshiba and formed Toshiba Storage Device in 2009, the HDD industry has been dominated by five companies: Seagate, Western Digital , Hitachi Global Storage, Toshiba, and Samsung Electronics. After the two major mergers in 2011 mentioned above, there will be three major players left. Toshiba, which owns around 10% of the market, is now receiving a lot of attention.

According to market research firm IDC, in the second quarter of fiscal 2011 which ended in December, Western Digital had a 31.25% market share of shipments on 52.2 million hard drives sold. Seagate was in second place with a 29.28% market share on shipments of 48.9 million units. Hitachi Global Storage had a market share of about 13%, and Toshiba and Samsung ranked fourth and fifth with about 10% market share each.

Although Western Digital and Seagate have made acquisitions, past experience indicates that it will take a while before they see the full benefits as the reintegration process will probably drag down both companies. Aside from funds needed after the merger, and a transition period, hard drive buyers will not be happy to see any one supplier dominate. Therefore, buyers will try to balance the weight of each of their suppliers, as competition among suppliers benefits buyers the most. That is the reason why it is not likely for Western Digital or Seagate to capture as much as 40% or 50% market share. As many notebook vendors such as Hewlett-Packard (HP) and Dell are afraid of depending on one single supplier too much, as this could let them control prices, some orders may be given to the third biggest supplier, Toshiba. People in the market are watching to see if Toshiba can move to second place by seizing the opportunity resulting from the period when both Western Digital and Seagate are busy dealing with any issues related to the mergers.

As far as change is concerned, it is good for both supply/demand and pricing. Due to the unfavorable market conditions for notebook makers, hard drive devices have seen oversupply and falling prices for several seasons since the second half of 2010. As a result, hard drive makers have been cautious about managing capacity.

But now there are only three players left, supply and prices are expected to return to stability. In addition, the big-ticket deals by Western Digital and Seagate imply that the HDD industry still provides abundant business opportunities. However, some argue that hard drive makers have to pursue mergers in order to protect their market which is gradually being taken by solid state disk (SSD) makers.

Cloud computing and tablet PCs offer great growth

According the market research firm TSR, global shipments of hard drive devices in 2010 reached 650 million units, up 17.1% from 557 million units in 2009. Desktops, notebooks, netbooks, and other devices consumed about 516 million units in 2010, or 79.7% of total shipments. Notebook and netbook devices together accounted for 31.5%, more than any other category of devices. Consumer electronics devices, including digital video recorders, games consoles, in-car navigation devices, and DSCs, took 15.5% of total shipments. Shipments of hard drive devices for non-PC applications totaled 101 million units in 2010.

Looking to the future development of the HDD industry, the shipments proportion of non-PC applications has seen no significant growth for five years since the peak of 15% seen in 2005, and it is unlikely that there will be any major breakthrough in 2011. The HDD industry also faces big challenges in the PC-application field. Tablet PCs and Apple's MacBook Air adopt built-in SSDs for data storage, which has prompted other notebook makers to follow. IDC estimated global shipments of hard drive devices in 2010 might decrease by 2-3% as a result. IHS iSuppli estimates the market for tablet PCs may grow to 48 million units in 2011, taking away 18% market share from netbooks.

Facing threats from tablet PCs and the trend towards cloud computing, as well as falling prices due to strong competition, hard drive makers might move ahead of the trend and turn to the enterprise server market, which can provide higher profits, instead of sticking to the notebook and desktop markets.

In fact, hard drives specifically designed for servers account for 24% of total shipments, and the business opportunities cannot be neglected as Internet-based companies, such as Google and Facebook, continue to spend large amounts of money on building data centers. With a rapid accumulation of digital data and increasing resolutions of videos and graphics, demand for server-use hard drives can only increase. It is roughly estimated that such demand will increase by at least 15-20% annually in terms of units.

As a result, Seagate still decided to buy Samsung Electronics' hard drive division for US$ 1.375 billion in both cash and equities even though the department has been operating at a loss. The main reason is that Seagate targets Samsung's rich resources in semiconductors and the move can help it extend to markets other than desktops and notebooks. Both companies also strengthened their existing cross-licensing cooperation which will see Samsung provide Seagate with enterprise-class SSD semiconductor products while Seagate will provide hard drive devices for Samsung's desktops, notebooks, and consumer electronics devices.

As for the earlier merger, Western Digital's buyout of Hitachi Global Storage Technologies was motivated by Western Digital's desire to make rapid breakthroughs in the enterprise-class hard drive market, which has been led by Seagate in the past, and to add a new SAS product line to compete in the server market with the current largest provider, Seagate. The mindset of both companies in seeking the mergers show the growing importance of the enterprise hard drive market.

Fast accumulation of digital data lets hard drives and SSDs share the pie

In addition to creating business opportunities in the server market, cloud computing is also seeing huge demand from social websites and online services such as music downloads, as well as from data storage, mobile devices and home entertainment centers. It is estimated that the 10-year period from 2011 to 2020 will be a golden decade of next-generation DIY data management, which requires customized cloud computing.

However, even though mobile devices are rapidly becoming popular, it is still too early to say that SSDs, which are subject to physical limits including access-times and reliability, can fully replace hard drives. Some researchers estimate that hard drives offered about 300 billion gigabyte (GB) of storage capacity in 2010, which will rise to nearly 400 billion GB in 2011, and may reach one trillion GB in 2014 to meet fast increasing demand. On the other hand, SSDs, limited by cost and physical barriers, are estimated offer at most 100 billion GB by 2014. The numbers show SSDs will not clearly replace hard drives, and the impact on the hard drive industry may be under 5%, if at all.

Japan-earthquake a blow to market confidence regarding future supply of hard drives and SSDs

Facing the trends of tablet PCs and cloud computing as well as technical limits, the HDD industry in 2011 also received a blow from the massive earthquake in Japan on March 11, a catastrophe that forced upstream hard drive material suppliers, including Showa Denko, Furukawa Denko, Kobe Steel, TI, and TDK, to cut capacity or halt production. Shipments of hard drives may be affected if material suppliers can not return to normality in time.

Key components of hard drives, including disk heads, platters, and control chips are becoming more sophisticated as storage capacity increases rapidly. At present, major hard drive makers, such as Seagate and Western Digital, make about 70%-80% of disk heads by themselves and most of their factories are located in China and Southeast Asia. For platters, the key component is the substrate, which comes in two major types, aluminum and glass. Glass substrates offer thinness, good resistance to shock, and smoothness, and therefore are mostly seen in 2.5-inch disks adopted by notebooks, desktops, servers, and video players, while other devices adopt less costly aluminum substrates.

However, upstream material supply was disrupted and hard drive makers stopped giving quotes to branded notebook vendors after the Japan earthquake. In the second quarter of 2011, demand for hard drives may be down 5-10% from the previous quarter as notebook makers revise down their estimated shipments. Due to the fact that it is hard for material suppliers of hard drives to regain normal capacity swiftly, shipments of 2.5-inch and 3.5-inch hard drives may be delayed because of lack of controller chips made by TI and others. It is estimated that in the middle and late part of the second quarter, when the current stock of components is used up, there will be a shortage of hard drives. Shipments in the second quarter will at least decrease by 15-20% from the first quarter. Based on a normal quarterly supply of over 160 million units of hard drives, shipments in the second quarter will be about 130 million, creating a gap of 15-20%.

Even though hard drive makers are aggressively looking for other sources of materials, even if the can find new suppliers, their new products still need to be certified by notebook clients. It is estimated that a full recovery of hard drive supply will not be seen until the third quarter of 2011, at the earliest. Therefore, if upstream material supply has still not recovered in the third quarter, notebook vendors will probably have to miss the opportunity to launch new products for the year-end shopping season.

The earthquake and ensuing limited power supply in Japan are not just a blow to confidence in hard drive supply, but have also created large uncertainty for the NAND flash industry which is considered to have the possibly of taking away market share from traditional hard drive makers. Toshiba, the world's number two NAND flash supplier, mainly depends on Shin-Etsu Handotai, which was seriously damaged in the earthquake, for the supply of silicon wafers. It is estimated that NAND flash supply from Toshiba and SanDisk will be down 10% in the first half of 2011 due to the disaster, or an about 4% decrease in global NAND flash bit supply.

Perpendicular recording faces limits

Apart from the impact from the external environment and mergers, hard drive makers are also expected to hit the limit of perpendicular recording technology in 2011. Each maker has been striving to take a leading position in technologies to enhance recording density and mass production. The technologies, which include DTR (Discrete Track Recording), Bit Pattern Media, and Heat Assisted Magnetic Recording (HAMR), are being developed by the makers to maintain their advantage of increasing storage capacity by 20-30% each year.

For traditional hard drives, the decreases in storage cost per unit, and growth rates in capacity are superior to other storage devices such as SSD, optical disc, and magnetic tape.

The competition between hard drive makers to increase storage capacity has not stopped even though mainstream built-in hard drive capacity in notebooks has reached 500GB, and storage capacity demand from desktops has not increased. It is estimated that the technologies allowing a single platter to store as much as 1TB of data will start to mature by the end of 2011. By then there may be 3.5-inch hard disks offering 4TB storage capacity, hitting the limit of perpendicular recording. The end of 2011 or early 2012 may see the introduction of brand new recording technologies within the HDD industry, and this will be a key period during which hard drive makers will show off the results of their research and development.

As perpendicular recording capacity is reaching its limit, the major players have invested US$500,000 each to form a new technology alliance to keep their market shares from being eroded. They will jointly develop the next-generation hard drive storage technology, Shingled Magnetic Recording (SMR), which can reach ultra-high storage densities of as much as 50TB per square inch. In so doing, they hope to ensure their market-leading positions and profitability for the future

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