April 20, 2018 | Equity Research
IT Hardware, HDD/SSD, Mobility & Networking Weekly IT Hardware & Feedback on Apple & HDDs (WDC / STX) Communications Previews, NAND Pricing… Networking
Investor Feedback on Apple & HDD (W. Digital & Seagate) Previews: Following our detailed preview reports on Apple (link), W. Digital (link), and Seagate (link), we thought we would highlight some
investor feedback: (1) Apple – An Abrupt Shift in Sentiment (from “It Doesn’t Matter” to “How Weak?” – re: iPhone): We received little investor pushback on our consistently cautious view and now reduced iPhone ship estimates (50MM in F2Q18 and ~40MM in F3Q18) given our analysis of ongoing weak demand data points through C1Q18. This was supported by TSMC’s disappointing 2Q18 outlook / comments on high-end smartphone weakness (Apple accounting for +20% of TSMC’s revenue in 2017). We found investors increasingly focused on blended iPhone ASP ($/unit) downside vs. our $750 estimate (downside to ~$720-$730 range?). We think investor sentiment is expecting a $100B+ share repo authorization (2-3 year timeframe) and 30%+ dividend increase (upside into the 50%+ range; vs. +11% avg. over the past 4 years). (2) HDDs / Flash –Nearline HDD Upside; A Wait-and-See Approach to Flash / SSD Trends: Nearline HDD demand sustainability into 2Q18 / through 2018 will be a key focus following what is expected to be strong 1Q18 results (e.g., IDC’s prelim estimates implying 85%+ yr/yr capacity ship; +20% q/q). We continue to find few investors asking about Seagate’s HAMR vs. WD’s MAMR tech for next-gen (16TB+) high-cap HDDs, though we think this will become more important through 2018. We model WD’s Flash bits shipped at - 6% q/q; -9% blended ASP ($/GB). Focus on pricing trends into 2Q18 and tightening supply / demand set-up into 2H2018. Please see our WD and Seagate EPS scenario analysis on pages 18 and 21. NAND Flash: Key Questions / Considerations When Thinking About Industry Pricing Data. We think NAND Flash pricing concerns are overdone. As we continue to field a lot of investor questions on Flash pricing trends – spot vs. forward contract pricing trends (via InSpectrum & DRAMeXchange) - we think there are some important (overlooked) considerations: (1) How Much Flash Volume is Sold in Spot? While spot pricing has led contract pricing trends (focus being on 128Gb TLC NAND trends over the past few weeks – implied avg. at - 11% q/q in 1Q18, per InSpectrum; DRAMexChange doesn’t track any TLC pricing), our discussions suggest that there is very little Flash sold on the spot market. (2) What’s Exactly Tracked (~60% of Total NAND Flash Bits Shipped at 256Gb – Not Tracked)? While DRAMeXchange doesn’t track TLC NAND (IDC est. at ~60% of total Flash bits), we would also note that InSpectrum data doesn’t include any 256Gb MLC / TLC pricing, or ~80% of total TLC Flash bits shipped Aaron Rakers, CFA in 4Q17; ~60% of total Flash (IDC estimates). (3) What About Cost Senior Analyst|314-875-2508 ($/Gb) Execution? We think a key focus through 1Q18 earnings (and aaron.rakers@wellsfargo .com thereafter) should be on each companies’ comparative expectation / Joe Quatrochi, CFA ability to execute on bit production cost declines – e.g., WD has Associate Analyst |314-875-2055 consistently highlighted a ~20% per annum cost reduction with 3D [email protected] NAND technologies (i.e., utilization ramps, tech. transitions [64L to Jake Wilhelm, CPA 96L], string vs. single-stack, die size shrink, CuA, etc.). Associate Analyst |314-875-2502 [email protected]
Please see page 27 for rating definitions, important disclosures and required analyst certifications. All estimates/forecasts are as of 04/20/18 unless otherwise stated. 04/20/18 17:25:36 ET
Wells Fargo Securities, LLC does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors should consider this report as only a single factor in making their investment decision. IT Hardware & Communications Networking Equity Research
Continued…
The Week Ahead – A Few Highlighted Thoughts: Earnings season will be in full swing this week (see our earnings calendar / points of derivative focus on page 3):
1. NAND Flash Commentary (SK Hynix, Samsung, & Western Digital): In addition to the aforementioned thoughts on NAND Flash pricing trends / considerations, we will be focused on commentary related to NAND Flash supply / demand and pricing trends and 3D NAND progression (64-layer yield ramps / cost reduction expectations, 96-layer and QLC timing?).
2. Nidec Results (4/25; before market): We will be focused on Nidec’s results / outlook commentary as providing validation to what is now an anticipated strong HDD earnings season driven by high-cap / nearline HDDs. As a reminder, Nidec is the leading HDD spindle motor provider and has continued to maintain a ~100% share position for helium-filled high-cap HDDs.
3. iPhone Demand Data Points (Verizon & AT&T Upgrade Rates): Smartphone upgrade rates in focus (e.g., iPhone 8 / X cycle); Wells Fargo Analyst, Jennifer Fritzsche, estimates flat yr/yr upgrade rate trends for Verizon and AT&T at 5% and 4%, respectively.
4. Cloud Capex: A number of cloud capex data points will be released this week – Google, Facebook, Microsoft, & Amazon. Forward spending commentary will be a focal point following strong high- capacity HDD capacity shipped in the March quarter (IDC estimates +87% yr/yr). In addition to the high-cap HDD read-throughs, we would note that our industry discussions have suggested that 50%+ of total enterprise SSDs are consumed by the hyper-scale cloud vendors. We expect a derivative focus on cloud capex related to Arista (30%-50% of total revenue derived via the cloud vertical; Microsoft historically representing the only 10%+ customer at 16% over the past two calendar years).
Wells Fargo Tracking of Job Listings: Our weekly tracking of job listings would highlight (1) the lowest level of Commvault job openings since 2011 – we believe notable following Elliott Management’s announced involvement. (2) Nutanix’s total job listings stood at 571 exiting last week (~50% sales- related), representing the highest level we have seen and up 50% since the end of 2017. We continue to view Nutanix’s open job listings as reflective of ongoing strong fundamentals. (3) The number of Pure Storage sales listings declined for a fifth consecutive week after reaching an all-time high in mid-March.
2 | Wells Fargo Securities, LLC
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ITHardware, HDD/SSD, Mobility & Networking Weekly March Quarter Results Calendar – 4/23-4/27 (Week #2):
| Wells FargoSecurities, LLC
Time Domestic Int'l Company Ticker Date (ET) Call in # Call in # Passcode Key Topics / Thoughts:
Focus on cloud-demand related commentary. We will also be interested in thoughts on capex/datacenter build-out Alphabet (Google) GOOGL 4/23/18 4:30 PM n/a n/a n/a trends and thus a read-thru for HDDs / networking equipment.
Updated thoughts on NAND Flash demand, pricing, and 3D NAND commentary. SK Hynix previously guided SK Hynix 000660-KR 4/23/18 8:00 PM n/a 82-31-810-3061 5796 NAND bit ship down low-single digits seq. in 1Q18; bit ship +40% yr/yr range in 2018.
Focus on enterprise software demand; geographical/vertical-specific and cloud-related comments of interest. We SAP SAP - DE 4/24/18 8:00 AM 929-477-0353 44-0-330-336-9105 8849562 continue to be interested in SAP's views on convergence between software and hardware strategies.
Corning GLW 4/24/18 8:30 AM 800-230-1074 612-288-0329 n/a Gorilla Glass used on iPhone screens Apple: iPhone / smartphone upgrade cycle dynamics - Wells Fargo Telecom Services Analyst, Jennifer Fritzsche, Verizon Communications VZ 4/24/18 8:30 AM 888-455-3018 773-799-3816 VERIZON estimates Verizon's upgrade rate at 5% in 1Q18, flat vs. a year ago. Networking: Capex spending trends & 5G
commentary Texas Instruments TXN 4/24/18 4:30 PM 323-794-2093 323-794-2093 5467397 Interested in derivative thoughts on server market.
LG Display 034220-KRX 4/24/18 9:00 PM n/a 60-3-2718-4788 658594; 72048 Apple-related commentary
Canon 7751-JP 4/25/18 2:00 AM n/a n/a n/a Derivative read-thru for HP's printer division; Canon remains primary/sole provider of printer engines into HP Inc.
Capex spending trends; continuing to focus on cloud / internet-related capex spending, though noting that Twitter is Twitter TWTR 4/25/18 8:00 AM n/a n/a n/a relatively small when compared to others (Amazon, Google, Microsoft, etc.) TE Connectivity TEL 4/25/18 8:30 AM 800-230-1092 612-288-0329 n/a 100GbE Ethernet demand commentary
Largest provider of HDD spindle motors. We will be interested in the company's enterprise spindle motor shipments as Nidec Corp 6594-JP 4/25/18 9:00 AM 800-239-9838 44-0-800-358-6377 NIDEC well as forward looking commentary. We believe mix of helium-related shipments will be an interesting data point.
Amphenol Corporation AMPH 4/25/18 1:30 PM 888-455-0949 517-623-4547 LAMPO Component supplier for iPhone antennas; commentary on 100GbE Ethernet adoption
F5 Networks FFIV 4/25/18 4:30 PM 800-593-9913 212-287-1824 F5 Networks IT Spending / networking demand trends Apple: iPhone / smartphone upgrade cycle dynamics - Wells Fargo Telecom Services Analyst, Jennifer Fritzsche, AT&T T 4/25/18 4:30 PM 866-232-4457 612-332-1213 n/a estimates AT&T's upgrade rate at 4% in 1Q18, flat vs. a year ago. Comments on adoption of non-subsidy plans; Networking: Capex spending trends & 5G commentary
QUALCOMM QCOM 4/25/18 4:45 PM 866-566-8589 706-634-8091 39466125 General demand trend thoughts; any updates on pending Apple litigation
Focus on any incremental thoughts on capex/datacenter build-out trends and thus a read-thru for HDDs - Facebook FB 4/25/18 5:00 PM 866-554-3009 n/a 1279727 company guiding 2018 capex at $14-$15 billion vs. $6.7B in 2017.
Updated thoughts on the company's server positioning, including the company's EPYC server chip traction / Advanced Micro Devices AMD 4/25/18 5:00 PM n/a n/a n/a expectations. Comments on NAND supply / Demand dynamics and 3D NAND ramp. Samsung had guided to flat seq. NAND bit ship in 1Q18; +40% yr/yr in 2018. We will be interested in potential impact from mid-March fab power Samsung Electronics 005930-KR 4/25/18 8:00 PM n/a 82-31-810-3063 7789; 94707 outage (estimated as impacting 50k-60k wafers; 11% of monthly output). Mobile segment results remains derivative focus for Apple. Avnet AVT 4/26/18 11:00 AM n/a n/a n/a Derivative thoughts on component pricing trends Cypress Semiconductor CY 4/26/18 4:30 PM 517-308-9119 517-308-9119 Cypress Provider of NOR / NAND flash; NAND flash pricing expectations Flex FLEX 4/26/18 5:00 PM 877-201-0168 n/a Q4Flex General thoughts on enterprise / IT hardware demand dynamics. Focus on Cloud / hyper-scale data center demand commentary, Skylake / Purley demand update, 3D NAND / SSD- Intel INTC 4/26/18 5:00 PM 877-303-7005 973-935-8154 5972879 related commentary, and update on PC channel inventory levels Focus on any incremental commentary related to AWS. We will also be interested in thoughts on capex/datacenter build- Amazon AMZN 4/26/18 5:30 PM n/a n/a n/a out trends and thus a read-thru for HDDs.
We maintain our F3Q18 estimates at $4.94B / $3.35. This compares to WD’s guide at ~$4.9B / $3.20-$3.30; street estimate at $4.93B / $3.30. Points of focus include: 1.) Pricing trends / expectations in NAND Flash, 2.) Western Digital WDC 4/26/18 5:30 PM 844-647-5494 661-378-9454 5188247 Thoughts on Toshiba's memory business / Flash Ventures JV. 3.) positioning in high-capacity / nearline HDD market (10TB / 12TB HDD adoption in focus), 4.) expectation / visibility of cloud spending. 5.) thoughts on shareholder return.
Equity Research Equity Azure Cloud momentum, capex (e.g. significant data center build-outs), PC demand trends, and commentary around Microsoft MSFT 4/26/18 5:30 PM 877-407-0666 201-689-8023 n/a Azure Stack (private cloud converged offering), etc.
KLA-Tencor KLAC 4/26/18 6:00 PM n/a n/a n/a 3D NAND equipment demand commentary.
NTT DoCoMo 9437-JP 4/27/18 4:00 AM n/a n/a n/a iPhone & iPad Demand-related commentary. Source: Company Data; FactSet; Wells Fargo Securities, LLC Commentary
IT Hardware & Communications Networking Equity Research
Highlighted Industry News / Thoughts: Wells Fargo Analysis (Reminder): iPhone Consumed 21% of NAND Bits shipped in 4Q17 With an increased number of investor questions late last week following TSMC’s negative June quarter guide in connection to weak high-end smartphone demand (e.g., Apple) we thought it would be helpful to provide a refresher on Apple’s consumption of NAND flash. We would note this news followed our March quarter preview, in which we lowering our forward iPhone estimates. As we highlighted in our detailed breakdown of NAND flash consumption late last year (link to note), we think investors should consider:
We estimate iPhone shipments in the December quarter consumed total NAND flash capacity of 9.4EBs, up 40% yr/yr and compares to 4.5EBs in the prior quarter. This implies the iPhone consumed approximately 21% of total NAND Flash bits in 4Q17, up from 11% and 19% in the prior and year ago quarters; 14% of NAND flash in all of 2017.
All smartphones accounted for 42% of NAND Flash during the December quarter, up from 38% in the prior quarter and unchanged from a year ago – this would leave us to estimate that Apple accounted for approximately 50% of the smartphone NAND consumption in 4Q17 (vs. 20% smartphone ship share).
We estimate average iPhone capacity during the December quarter reached a record 121GB/iPhone, up from 96GB and 86GB in the prior and year ago period.
According to IDC data, 30% of iPhone shipments in the December quarter were 256GB capacity option, up from 16% in the prior quarter. For iPhone X, IDC estimates 256GB accounted for 41% of shipments.
4 | Wells Fargo Securities, LLC
IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
TLC NAND Flash Pricing -1% W/W; TLC and MLC NAND Flash -3.2% and -1.4% Seq. Thus Far in 2Q18 As part of our ongoing reporting of NAND flash pricing, we would note according to InSpectrum data, average TLC $ per Gb was down 0.7% this week, average MLC $ per Gb was down 0.6%, and high capacity MLC and TLC (64Gb and 128Gb) was down 1.6%. TLC’s decrease was driven by a 4.7% decrease in the price of 128Gb. Thus far in 2Q18, we are tracking to NAND Flash spot pricing for TLC NAND to be approximately -3.2% sequentially and down 8.3% on a yr/yr basis, while MLC NAND pricing is trending at an average of -1.4% sequentially and up 1.6% yr/yr. InSpectrum data shows an approximate 11.4% sequential decrease in highest TLC capacities (64Gb and 128Gb) and a 32.4% yr/yr decrease.
Wells Fargo Securities, LLC | 5 IT Hardware & Communications Networking Equity Research
South Korean NAND Flash Exports Remain Strong: +105% Yr/Yr in 1Q18 (+112% Yr/Yr in March); Record SSD Exports +91% Yr/Yr in March (1Q18 +78% Yr/Yr) On a US$ basis, exports of NAND Flash in South Korea grew 112% yr/yr in March; leaving 1Q18 up 105% yr/yr (vs. +104% yr/yr in 4Q17). Imports of NAND Flash grew 12% yr/yr 1Q18. From a quantity basis, NAND Flash exports are up 36% yr/yr in March and up 37% yr/yr in 1Q18. We would note this compares to our prior analysis of January + February suggesting 1Q18 US$ exports up 95% yr/yr and units up 35% yr/yr. With a 5% m/m increase in the month of March, we would find average 1Q18 $/unit exported up 18% sequentially (+40% yr/yr).
Total SSD exports from South Korea grew to a record $682 million during March, an increase of 91% yr/yr. Total SSD exports in 1Q18 totaled $1.877 billion, an increase of 78% yr/yr and up 18% sequentially.
6 | Wells Fargo Securities, LLC
IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
Japan Memory Indices Highlight Increased Production / Inventories in February In addition to our reporting of South Korea NAND exports, we would also highlight our tracking of memory-related seasonally adjusted indies published as reported by Japan’s customs through the month of February. As illustrated below, Japan’s memory related production index increased 16% m/m during the month of February (vs. -17% m/m in January); this index was up 42% yr/yr during the month of February. Japan’s memory shipment index was up 1% m/m in February and compares to -7% m/m in January; +23% yr/yr. Japan’s inventory index increased 10.5% m/m in February, compared to a 1% and 5% m/m increase in December and January. We would note this represents the third consecutive month of m/m inventory index increases, respectively.
Wells Fargo Securities, LLC | 7 IT Hardware & Communications Networking Equity Research
Lam Research C1Q18 Results: Strong NAND Spending Continues; Expected 1H vs. 2H Weighted Investments Lam Research reported positive results for the March 2018 quarter, from which we are focused on the company’s updated thoughts on trends in the NAND Flash industry. Lam reported revenue of $2.89 billion (+34% yr/yr), slightly ahead of the consensus (FactSet) estimate at $2.85 billion and prior guide of $2.725-$2.975 billion. Lam reported shipments totaling $3.135 billion (+30% yr/yr) compare to prior expectations of $3.05-$3.3 billion. Lam expects March revenue in the range of $2.95-$3.35 billion (+26%- 43% yr/yr; prior consensus at $2.94B) and shipments at $2.85-$3.15 billion (+12%-24% yr/yr).
Key NAND Flash related data points include:
Lam reported that the Non-Volatile (NAND Flash) segment accounted for approximately 57% of total system shipments, or implying $1.8 billion, up 48% yr/yr (vs. +96% yr/yr in C4Q17) and +28% sequentially. The company highlighted it continues to see strong demand for 3D NAND related equipment as manufacturers continue to invest in technology transitions for new layer counts (e.g., 48- L to 64-L and beyond) and increased capacity. We would note that Lam highlighted one advanced etch win for a new NAND flash application with a major NAND vendor during the quarter.
Overall WFE spending is expected to grow in the low double digits in C2018 – reiterating that more than 85% of the growth in WFE yr/yr coming from memory (DRAM + NAND). However, LAM reiterated expectations of greater balance of DRAM and NAND spending in C2018. The company noted that NAND WFE is forecasted to be flat to slight up in 2018 with higher spending in 1H vs. 2H. We would note that the company expects a similar level of unqualified NAND capacity to be outstanding at the end of C2018 as exiting C2017 – e.g., suggesting continued capacity discipline by NAND vendors. As we previously highlighted, at Lam’s recent early March Analyst Day, we had highlighted the company’s forecast left us to estimate gen 3 (64-layer) at 9% of 2021 wspm, gen 4 (96-layer) at 48% and gen 5 and beyond (128-layer) at 39%, respectively. We think investors could be left to question this as a potentially slower than expected transition in 96-layer / beyond – we believe illustrating the increased difficulty / complexity beyond 64-layer. As a reminder, Western Digital is now shipping samples of the 96-Layer BiCS4 3D NAND to retail customers with expectations of meaningful production ramp 2HC2018.
While the company does not provide a breakdown of segment shipments by geography, we would note that Japan shipments were reported at approximately 11% of total, which implies -5% yr/yr (vs. +141% and +60% yr/yr in the September and December quarters); we would note this compares to a peak seen in 1Q17 at $362 million. While Sony and Micron could be Lam customers impacting Japan shipments, we think this continues to be driven by Toshiba / Western Digital’s 3D NAND transition – we would note that Toshiba recently announced that it was proceeding with its third round of investment (¥140B; $1.3B) for the installation of equipment, including deposition and etching equipment. Lam does disclose that inventory reflective of shipments into Japan customers (not reflected in deferred) totaled $526 million exiting the March quarter, up from $289 million in the prior quarter, respectively.
In terms of China investments in Memory and ramp in 2018, Lam only reiterated its prior comments that there continues to be conviction in China’s efforts to make balanced investments. The company reiterated that all investments coming from China domestic players will be in the $5 billion range (up $1-$2B yr/yr), but still account for 10%-12% of total WFE spending.
8 | Wells Fargo Securities, LLC
IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
Lam Research Highlights Potential Future Memory Architectures Lam Research published a piece last week laying out several new disruptive memory technologies currently being explored by the industry:
Phase Charge RAM (PCRAM): Offers performance on par with DRAM and is being considered as a potential main memory as well as for storage-class applications. The technology uses chalcogenide glass to change the memory states under the influence of heat. It passes an electric current through a resistor to switch the chalcogenide between low resistance and high resistance states correlating with the data value in the cell. Etching is difficult with PCRAM as the glass’ three materials have to be etched simultaneously with different etch rates for each material potentially leading to sidewall damage or profile bowing among other issues.
Magnetoresistive RAM (MRAM): A type of MRAM currently gaining traction in the industry is spin- transfer torque MRAM (STT-MRAM). STT uses electrons’ intrinsic spinning properties to reduce the current required to reach the threshold voltage required to activate a cell, saving power in the process. STT is fast enough to work in cache memory applications and offers potential scaling applications over large SRAM arrays built at the FEOL levels. Difficulties with MRAM include the fact that the cobalt-iron- boron and cobalt-iron magnetic layers are hard to etch because they don’t readily form volatile compounds with plasma gasses. Ion beam etching is a potential solution for this problem.
Restive RAM (ReRAM/RRAM): A potential long-term replacement for NAND flash; is faster being random access and bit alterable. Potential in 3D architectures and cross-point. RRAM’s material changes resistance between electrodes thereby creating a measurable change in resistance that can be used as a signal.
Hybrid DRAM: Hybrid memory cubes that put DRAM cells in closer proximity to shorten the data transmission pathway.
Source: Lam Research; Wells Fargo Securities, LLC
Facebook to Build Own Chips? Facebook is planning to design its own chips for use in consumer devices, artificial-intelligence software, and data centers according to the Wall Street Journal. Projects specifically cited to be served by the chips include connected speakers and virtual-reality headsets. Facebook is planning on designing ASICs and FPGAs for use in data centers. Last year, Facebook promoted Andrew Bosworth to oversee all of the company’s hardware business.
China Accelerates Chip Development after U.S. Trade Friction China is working toward further accelerating the development of its semiconductor market after the United States banned U.S. firms from selling parts to ZTE after the company was caught selling goods to Iran. Reuters reports that Senior Chinese officials are holding meetings with industry heads and regulators to set further aggressive plans for chip expansion. China has already told domestic manufactures that they want locally-produced chips in 40% of all smartphones in the domestic market by 2025 and the country’s state-backed chip fund raised an estimated $32B in additional financing last month. China’s state- sponsored chip industry continues to be a key point of contention between the United States and China and tensions show no sign of easing soon.
Wiwynn Expecting Strong ODM Server Growth in 2018 Last week DigiTimes reported that ODM server vendor, Wiwynn, is expected to see strong demand for its server products in 2018. It was noted that the company reported revenue of NT$85.67 billion (~$2.9B USD) in 2017, up 170% yr/yr, while 1Q18 revenue of NT$39.4B increased 280% yr/yr. The article reported that Wiwynn is currently supplying servers to Facebook and Microsoft but could enter the supply chain of Amazon after completing the POC process. However, it was noted that since Amazon currently
Wells Fargo Securities, LLC | 9 IT Hardware & Communications Networking Equity Research
has four server suppliers, Wiwynn would likely obtain only a limited number of orders with the potential to see increased volumes as Amazon grows.
As we have previously highlighted, IDC estimates total ODM / Direct vendors accounted for 25% of x86 server revenue in 2017, up from 20% in 2016. When including Chinese / Taiwanese vendors (Sugon, Inspur, etc.), we would note they accounted for approximately 35% of revenue in 2017 (vs. 28% in 2016). These vendors accounted for 36% of shipments in 2017 (vs. 29% in 2016), growing 34% yr/yr.
Next Platform Highlights Evolution of Hyper-Converged Storage; Profiles Datrium (Founded by Ex-Data Domain Founder & Engineers) Last week the Next Platform highlighted that while hyper-converged storage has seen significant adoption and has begun to move up the stack from mid-range environments into larger enterprises, challenges are becoming evident – specifically highlighting infrastructure resources to datacenter sprawl as well as issues related to primary and secondary storage management. The article highlighted a growing number of companies looking to address this issue with software-defined storage, including ClearSky Data, Cohesity, and Rubrik (note: company recently reporting it is approaching a $300MM/annum bookings run rate) – we would also include Commvault’s HyperScale solution. The article profiled startup, Datrium:
Datrium has focused its efforts on building off the concept of a hyper-converged architecture to provide more of a tier-one scalable hyperscale-like architecture. Datrium believes that its DVX solutions offer a new type of convergence architecture with two tiers, which does both consolidation and backup of VM workloads in a single system; scalable up to 1PB of capacity in a single system. Like other hyper- converged solutions, Datrium runs on commodity x86 servers and leverages a combination of flash and HDD storage. The DVX stack is comprised compute nodes and data nodes – only active data is stored on the compute nodes and anything that needs to be persisted is pushed to the data nodes. A key differentiation is that DVX compute nodes are stateless (e.g., they do not communication with / rely on each other or with the storage nodes).
The company has developed a content-address file system, which focuses on the importance of data integrity as part of its system – leveraging principles of blockchain technology in cryptocurrency. The company notes that it has used a crypto-hash algorithm for parts of data within a VM – making it immutable. This functionality allows DVX to inspect each hash multiple times per day and can also be leveraged for deduplication. The company notes that customers typically recognize 3:1 data reduction with its platform, but when replicating to the cloud, Cloud DVX will deduplicate across sites to provide as much as 4.5:1 reduction.
At AWS re:Invent in late 2017, Datrium pre-announced a cloud-native version of DVX, which allows porting the software to the cloud provider and utilizing AWS EC2 and S3 resources to offer backup and restore capabilities. The company most recently introduced DVX 4.0, which included support for Oracle RAC and improved VM fault tolerance, and data / security backup.
Datrium was co-founded in 2012 by ex-Data Domain founder, Brian Biles, as well as Data Domain’s CTO, an initial NetApp SnapVault architect among others. The article notes that Datrium has more than 300 DVX deployments in the past 7 quarters with customers including Siemens, Oberto, and Osprey Packs. We would note the company has raised $110 million of cumulative funding (latest $55MM Series C round in December 2016) from New Enterprise Associates and Lightspeed as well as an impressive list of private investors including VMware co-founders Diane Greene and Mendel Rosenblum, Frank Slootman (prior CEO of Data Domain and ServiceNOW, Nutanix board member; also investor in Rubrik), and Data Domain co-founder, Kai Li.
IBM Details In-Memory Computing Architecture for Artificial Intelligence Workloads Last week IBM published a research paper detailing the company’s views on in-memory computing, which it believes will be best set for use in accelerating Artificial intelligence / resource intensive workloads. IBM believes that one of the biggest challenges in the fundamental design of today’s computers is that they are based on legacy von Neumann architectures, or rather requiring data to be moved between memory and processing units to be processed. IBM has proposed a new architecture that consists of mixed precision in-memory computing, which integrates computational memory units and enables these processors to carry out most of the data processing tasks. The legacy architecture would then be used to iteratively improve / refine the accuracy of the results. This architecture relies on phase change memory (PCM) devices that are programed to reach a specific level of conductivity and can handle most data processing without needing to transfer to a standard CPU or HPU. However, we think it is important to note that phase change memory can currently only store 1MB of memory, or rather a small fraction of what could be potentially required of it. IBM does believe that has PCM capacities increase, it could look to link several PCMs together by building larger arrays of the devices.
For the paper, IBM used a prototype chip with a million PCM devices consisting of an array of 512 word lines by 2048 bit lines integrated in 90nm CMOS technology to solve 40 linear equations. The computational memory unit was simulated with various degrees of device variability, testing both an IBM POWER8 CPU and a NVIDIA P100 GPU as high precision computing units. IBM found that maximum measured energy gains compared to the CPU-based and GPU-based implementations ranged from 6.8x
10 | Wells Fargo Securities, LLC
IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
with device variability comparable to that of the current prototype PCM chip and up to 24x when assuming reduced device variability that could be achieved in future optimized chips.
IBM 1Q18 Results – Storage Revenue Down 15% Yr/Yr IBM reported revenue of $19.07B +5% yr/yr and flat on a CC basis vs. FactSet consensus of $18.83B. Company reaffirms FY2018 EPS guide of at least $13.80 which compares to street consensus of $13.83. IBM continues to expect FCFF of approximately $12B. Strategic imperative revenue +15% yr/yr (10% in CC) led by cloud and security.
Cloud Revenue: Cloud revenue up 22% yr/yr in CC with annual run rate of $17.7B. as-a-service cloud revenue +20% yr/yr in CC with annual run rate of $10.7B.
Systems: IBM’s Systems segment grew 4% yr/yr in CC. IBM Z revenue grew 54% yr/yr with margin expansion. IBM Z performance was driven by z14 with new workloads growing faster than traditional MIPS. Adoption of z14 was wide based but suggests that IBM had to sell its mainframe capacity at a discount compared to its z13. Power grew for the second consecutive quarter. Began transition to POWER9 in the quarter with the first installment of supercomputers at the U.S. Department of Energy and started shipping POWER9 entry systems designed for AIX, IBM I, and Linux workloads. We would highlight that the Power Systems business has not yet recognized the 9,000 nodes that it will install in the Summit and Sierra supercomputers it is building for the U.S. Department of energy.
Storage Hardware: Storage down 15% yr/yr after four consecutive quarters of growth driven by increased competition and pricing pressure. Gross margin down approximately 4% yr/yr but includes a 5% charge for systems cost. The decline was noted as partly due to weakness at the low end of the market, while it saw strength in high-end storage. IBM again noted strong growth in software-defined storage and cloud object storage.
Increasing Server Rack Power Densities Driving Need for Alternative Cooling Strategies Last week an interesting DataCenter Knowledge article highlighted the workload requirements of big data, artificial intelligence / machine learning, and related technologies are driving server rack power densities:
It was highlighted that many data center operators have seen rack power density increase to the 5- 13kW range from 3-5kW in 2010, while some have seen racks consume as much as 25-40kW. It was noted that for colocation providers the typical power density in a data hall has risen from 150 watts per square foot to 250-300 watts per square foot, with some citing as high as 400 watts.
The article notes that some factors causing this increase: (1) Server Virtualization: This allowed for server consolidation, but increased server utilization. The article notes organizations could consolidate five servers running at 25% of capacity to two running at 85%-90%. It was noted that some organizations are utilizing higher power densities as a way to manage capex. (2) New / More Powerful Hardware: It was noted that servers require more power as CPU vendors continue to keep up with Moore’s Law. Additionally, new servers include more I/O cards, storage, memory, accelerators (GPU / FPGAs). However, we would highlight quotes in the article from the co-founder and COO of RackTop Systems (a provider of high-performance software-defined storage) as noting adoption of SSDs is helping data center operators deliver better space density – suggesting that over 700TB of SSD storage can be deployed in a 4U rack vs. 288TB of HDD capacity.
The article notes that this rise in rack power density has significant implication for data center design, particularly the cooling technology required. It was suggested that high density data centers may require containment systems that separate the cold supply airflow from the hot air exhaust – this could also result in cooling technologies being located next to the compute load (vs. on the perimeter). The article also highlights other alternative cooling strategies as including water cooling systems as well as some experimenting with submerging servers in dielectric liquids.
China Approval of Toshiba Memory Deal Delayed to May 1st; Focus on Potential Conditional Provisions The Korea Times reported overnight that China’s regulators (MOFCOM) are seeking more protections for Chinese companies prior to approving the proposed consortium acquisition of Toshiba Memory. It was suggested that China wants Toshiba Memory to transfer key technologies and reduce payments (e.g., royalties) by Chinese firms for patents as a condition for approval – the article notes that Chinese NAND flash fabrication companies spend billions of dollars each year in royalties to patent owners given the late entrance into the market. U.S. / China trade tariffs were also noted as negatively impacting the close of the deal. It was also noted that SK Hynix’s involvement in the deal (convertible debt to as much as 15% voting right) has been a concern. The article notes that the approval by Chinese regulators (MOFCOM) has been delayed to May 1st after the first attempt to close the deal failed.
Wells Fargo Securities, LLC | 11 IT Hardware & Communications Networking Equity Research
YMTC Reportedly Receives First 3D NAND Orders Last week it was reported by DigiTimes that Yangtze Memory (China’s 3D NAND efforts), has obtained its first orders for commercial production of over 10,000 3D NAND flash chips for use in 8GB SD memory cards. As we highlighted in our prior IT Hardware Weekly, YMTC expects to commence volume production of 3D NAND at the end of 2018. Initial production will be at 32-layer 3D NAND, while the company plans for 64-layer products in 2019.
AT&T Announces 5G Evolution Technology Expansion in 117 New Markets AT&T announced late last week that it was launching 5G Evolution in parts of 117 new markets, totaling 141 markets now served with this technology. The company noted that it plans to make 5G Evolution technology and capabilities available in over 500 markets later this year, including in parts of Baltimore; Charlotte, N.C.; Cleveland; Denver; Detroit; Jacksonville, Fla.; Kansas City; Las Vegas; New York City; Philadelphia; Portland; Raleigh; Salt Lake City; Seattle; and Washington, D.C. The company also announced that it is also making LTE-LAA available in 3 new markets, bringing the total number of markets served to seven. LTE-LAA was noted as capable of delivering up to 1Gb/s of performance. AT&T plans to make this technology available in at least 24 markets in 2018.
GE CIO Joins Exascale Computing Project The Exascale Computing Project (ECP) announced that Dave Kepczynski, CIO of GE Global Research, would join as the new chair of the Industry Council. The Exascale Computing project is a collaborative project led by the Department of energy laborites focused on accelerating the delivery of a capable exascale computing ecosystem. The ECP Industry Council provides advice and guidance to the ECP director and leadership team with the aim of improving high performance computing’s use to the U.S. industrial sector. Mr. Kepczynski replaced Dr. Michael McQuade who was the Industry Council’s inaugural chair and is senior vice president, Science and Technology, at United Technologies Corporation.
12 | Wells Fargo Securities, LLC
13 Coverage / Valuation Summary: ITHardware, HDD/SSD, Mobility & Networking Weekly
|Wells Fargo Securities,LLC
Price 4/20/2018 P/E Price Tgt 5-Year P/E EV/Sales Price Tgt 5-Year EV/Sales Company Ticker Rating Target Price Mkt Cap Ent Value C2017A C2018E C2019E C2019E Median Min Max C2017A C2018E C2019E C2019E Median Min Max Apple AAPL MP $195 $165.72 $840,865 $678,168 17.1x 13.6x 12.7x 14.95x 12.9x 8.5x 15.9x 2.84x 2.53x 2.44x 2.97x 2.79x 1.72x 3.62x HP Inc. HPQ MP $21 $21.53 $35,255 $36,383 12.2x 10.9x 10.4x 10.18x 8.8x 5.6x 13.1x 0.68x 0.66x 0.67x 0.66x 0.61x 0.33x 0.74x EFI EFII MP $32 $29.15 $1,312 $1,326 16.8x 13.7x 12.6x 13.88x 18.2x 9.6x 24.9x 1.33x 1.26x 1.24x 1.36x 1.85x 1.01x 2.33x Super Micro SMCI MP $20 $17.45 $850 $895 12.0x 10.4x 8.2x 9.45x 12.5x 7.7x 19.3x 0.32x 0.29x 0.27x 0.31x 0.47x 0.26x 0.85x Cray Inc. CRAY OP $30 $22.40 $907 $736 n/a n/a n/a n/a 28.8x 13.9x n/a 1.88x 1.66x 1.29x 1.82x 1.31x 0.66x 2.55x HP Enterprise HPE MP $17 $17.29 $26,855 $25,863 14.4x 12.1x 11.3x 11.07x 11.4x 6.4x 14.1x 0.73x 0.85x 0.82x 0.81x 0.90x 0.44x 1.18x NetApp NTAP MP $62 $68.66 $18,396 $14,942 18.6x 17.0x 15.7x 14.14x 13.4x 8.5x 17.9x 2.60x 2.40x 2.27x 2.00x 1.32x 0.50x 2.47x Pure Storage PSTG OP $30 $20.64 $4,013 $3,415 n/a n/a n/a n/a n/a n/a n/a 3.34x 2.53x 2.04x 3.13x 2.31x 1.37x 8.04x Nutanix NTNX OP $60 $54.03 $7,686 $6,768 n/a n/a n/a n/a n/a n/a n/a 6.63x 5.86x 4.91x 5.52x 4.00x 1.93x 8.66x Commvault CVLT OP $75 $69.95 $3,144 $2,693 73.0x 51.3x 29.4x 31.56x 42.5x 19.7x 52.5x 3.95x 3.55x 3.45x 3.74x 2.69x 1.58x 6.03x Seagate STX MP $52 $59.64 $16,987 $19,174 14.3x 11.8x 11.6x 10.13x 10.1x 6.4x 12.6x 1.81x 1.77x 1.74x 1.54x 1.30x 0.84x 1.86x Western Digital WDC OP $115 $89.56 $26,649 $32,405 7.0x 6.2x 6.2x 7.99x 9.2x 6.1x 13.4x 1.62x 1.53x 1.47x 1.81x 1.27x 0.35x 1.78x Juniper Networks JNPR MP $23 $24.35 $8,499 $7,517 13.8x 13.8x 12.1x 11.46x 13.4x 10.0x 19.3x 1.50x 1.60x 1.56x 1.46x 1.91x 1.34x 2.49x
Cisco CSCO OP $52 $44.09 $212,404 $178,087 16.8x 16.8x 15.8x 18.63x 12.2x 9.7x 16.9x 3.70x 3.57x 3.48x 4.22x 2.16x 1.54x 3.72x Arista Networks ANET MP $270 $260.65 $19,382 $17,885 38.2x 38.2x 32.9x 34.07x 34.1x 19.8x 89.6x 10.86x 8.47x 6.90x 7.17x 5.17x 2.86x 9.94x
Price EV/EBITDA Price Tgt 5-Year EV/EBITDA EV/FCF FCF Yield 5-Year Median Company Ticker Rating Target Price Mkt Cap Ent Value C2017A C2018E C2019E C2019E Median Min Max C2018E FCF Yield EV/FCF Apple AAPL MP $195 $165.72 $840,865 $678,168 9.1x 8.1x 7.9x 9.6x 8.5x 5.2x 11.7x 9.7x 10.4% 10.4% 9.7x HP Inc. HPQ MP $21 $21.53 $35,255 $36,383 8.3x 8.1x 7.9x 7.7x 5.6x 2.9x 8.7x 11.4x 8.8% n/a n/a EFI EFII MP $32 $29.15 $1,312 $1,326 10.6x 9.7x 8.9x 9.8x 10.6x 6.2x 14.6x 22.8x 4.4% n/a n/a Super Micro SMCI MP $20 $17.45 $850 $895 6.3x 6.6x 5.8x 6.6x 7.5x 4.8x 14.6x n/a n/a n/a n/a Cray Inc. CRAY OP $30 $22.40 $907 $736 n/a n/a n/a n/a 13.8x 7.5x 37.7x 25.8x n/a n/a n/a HP Enterprise HPE MP $17 $17.29 $26,855 $25,863 5.0x 4.9x 4.7x 4.6x 5.5x 3.0x 6.7x 11.6x 8.6% 6.7% 15.0x
NetApp NTAP MP $62 $68.66 $18,396 $14,942 11.9x 11.2x 10.4x 9.1x 6.1x 2.5x 10.8x 12.4x 8.1% 8.1% 12.4x Pure Storage PSTG OP $30 $20.64 $4,013 $3,415 n/a n/a n/a n/a n/a n/a n/a 58.4x n/a n/a n/a Nutanix NTNX OP $60 $54.03 $7,686 $6,768 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Commvault CVLT OP $75 $69.95 $3,144 $2,693 32.8x 25.2x 19.2x 20.8x 17.8x 8.7x 23.8x 22.2x 4.5% 4.4% 22.5x Seagate STX MP $52 $59.64 $16,987 $19,174 9.2x 8.1x 8.1x 7.2x 6.6x 4.5x 8.6x 16.6x 6.0% 6.3% 15.9x Western Digital WDC OP $115 $89.56 $26,649 $32,405 5.5x 5.3x 5.2x 6.5x 5.1x 1.5x 7.3x 12.1x 8.3% 9.0% 11.2x Juniper Networks JNPR MP $23 $24.35 $8,499 $7,517 5.5x 7.2x 6.5x 6.1x 7.4x 5.3x 9.6x 9.5x 10.5% 13.0% 7.7x Cisco CSCO OP $52 $44.09 $212,404 $178,087 11.8x 11.3x 10.9x 13.2x 6.6x 4.8x 10.6x 11.9x 8.4% 8.6% 11.6x Arista Networks ANET MP $270 $260.65 $19,382 $17,885 29.5x 24.9x 20.6x 21.4x 19.3x 10.2x 49.1x 27.5x 3.6% 3.7% 27.1x Note: OP = Outperform; MP = Market Perform Source: Company Data; FactSet; Wells Fargo Securities, LLC Estimates
Equity Research Equity
IT Hardware & Communications Networking Equity Research
Noteworthy Company-Specific News/Thoughts Review:
Apple (AAPL – $165.72 – Market Perform)
Mobile Phone Production in China -13% Yr/Yr in 1Q18 In addition to our tracking of export data, we would highlight China’s reported mobile phone production data, which we think could be used for a proxy of supply. In looking at this data we believe the industry has been very actively managing supply vs. weaker demand dynamics through 1Q18. During the March quarter, China’s total mobile phone production reached 415.8 million units, down 13% yr/yr (-25% sequentially; vs. -27% seq. average for 1Q over the prior three years). This compares to -7% and -21% yr/yr in September and December quarters, respectively. We would note that mobile phone production compares to our estimate of China exports + domestic China shipments at 365.4 million – implying a gap of 50.3 million units, down from 69.3 million and 118 million in the prior and year ago periods.
F2Q18 Preview: Reduced iPhone Estimates; Expectations of +$100B Share Repo Our Call (Apple F2Q18 Preview; 5/1, AMC): While the iPhone-related data points we track have left us continually cautious, investor focus has remained on the company’s upcoming capital return update – we think Apple could outline plans of an incremental $100B+ of share repo with a 30%+ increase to its quarterly dividend. We lowered our March quarter estimates to $60.0B / $2.62, from $61.8B / $2.73 (consensus at $61.5B / $2.71) compared to Apple’s $60-$62B / implied $2.56-$2.76 guide. This reflects our new iPhone ship estimate at 50.1M with a blended ASP ($/unit) at ~$750, compared to our prior 53.9M / $765 – vs. street estimate at 53.7MM / $744 (range: 51-62MM). With numerous reports suggesting / indicating Apple’s logical expansion of OLED to additional iPhone models in 2018 (including a larger 6.5” iPhone Plus model), we think investors will likely maintain a cautious view on forward demand drivers / upgrades / elasticity in Apple’s iPhone installed base in F2018. We expect particular focus on Apple’s results and thoughts in the China market in which we have highlighted weak trends through 1Q18. We also de-risked our June and September quarter estimates by 3%-5%; our C2018 and C2019 revenue and EPS estimates now stand at $261.0B / $11.94 and $270.4B / $13.05 compare to our prior estimates of $267.9B / $12.22 and $278.2B / $13.04 (note: we now assume a ~6% / annum reduction in Apple’s fully diluted share count in F2019 and F2020; vs. -5% / annum average over Apple’s prior four fiscal years).
What Matters Most:
Capital Return: We Think Sentiment Reflects at Least a 30% Dividend Increase & Up to a $100B/annum Incremental Share Repo Authorization? Apple’s capital return update, or rather strategy to attain a net neutral cash position (vs. $163B net cash exiting F1Q18) going forward is a clear focus. Apple has increased its cumulative capital return program by $30-$50B in each of the past five years – we now consider whether Apple could outline a >30% dividend increase (vs. +11% avg. over the past four years, though maintaining a $11-$12B/annum payout) and an incremental $100B+ share repo program.
iPhone: Remain Cautious on March Qtr. Ship; Channel Inventory a Key Focus. Our quarterly Wells Fargo iPhone Ship Index continues to support our cautious view on iPhone shipments for the March quarter. Our analysis of the data points outlined below leaves us to estimate total iPhone shipments during the March quarter in the high-40 to 50M range. Apple’s iPhone channel inventory
14 | Wells Fargo Securities, LLC
IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
position will be a point of interest following a >3.5-4.0MM seq. increase in F1Q18 (highest q/q increase in Apple’s history).
Other: (1) Expecting Continued Strong Services Growth: We expect Apple to report continued momentum of its services revenue in the March quarter; we estimate +22% yr/yr. (2) Vendor Non- Trade Receivables: this balance sheet item (i.e., component purchases) increased significantly in F1Q18 to a record $27.5B (vs. $17.8B in F4Q17). (3) GM% considerations: Updated thoughts on memory pricing (DRAM in focus), as well as FX impacts.
Please see our detailed report published on 4/18/18 for additional information.
TSMC Highlights Weakness in High-End Smartphones as Negatively Impacting June Quarter Guide TSMC reported revenue of $8.46B up 12.7% yr/yr but down 8.2% sequentially, in line with company guidance of $8.4-$8.5B. TSMC gave revenue guidance for 2Q18 between $7.8B and $7.9B, significantly below consensus estimates of $8.8B. TSMC expects continued softening smartphone demand in the upcoming quarter; specifically called out strength of Chinese smartphone market and weakness in very- high end smartphones. TSMC is the sole supplier of Apple’s iPhone A-series chips used in iPhones and iPads; iPhone X and 8 use TSMC 10nm while iPhone 7 uses 16nm. TSMC is set to produce 5nm chips for Apple in 2020 and 3nm chips in 2022. 10nm chips accounted for 19% of the company’s total wafer revenue in the quarter while 16/20nm was 22% of total revenue, this compares to 25% for 10nm and 20% for 16/20nm in the previous quarter. The company noted high utilization on its 16nm and 10nm lines. SMC increased its CapEx budget by $1B to add mask making capacity and pre-pay for tools. The company expects the overall semiconductor market excluding memory to grow by 5% in 2018 while foundry is expected to grow by about 8%. Management noted increased silicon content in smartphones due to functionality improvements in facial recognition and AR/VR video.
Western Digital (WDC – $89.56 – Outperform)
Western Digital Releases New 14TB CMR (Conventional / Perpendicular) High-Cap HDD Last week Western Digital introduced its new Ultrastar DC HC530 hard drive, a 14TB helium CMR (conventional magnetic recording) drive. The drive provides 75% more capacity than 8TB air drives, has 56% lower idle W/TB than 8TB Ultrastar air-filled drives, and has a 25% higher MTBF rating. The drive is a follow-on to Western Digital’s 14TB SMR (shingled magnetic recording) drive, the industry’s first 14TB SMR. The model has an areal density (Gbits/sq. in) of 904 compared to 1034 for Western Digital’s 14TB SMR device. The article noted that Tencent is adopting the drives for its data center after having previously deployed WDC’s 12TB HelioSeal HDDs.
We think it is interesting / important to note that WD’s new 14TB drives is an 8-platter / 16- head drive, which compares to Toshiba’s previously introduced (December 2017) 9-platter / 18-head 14TB HDD. Seagate did a soft introduction of their 14TB HDDs at the Open Compute Project (OCP) conference in March – our understanding is that these will also be 8-platter / 16-head high-cap HDDs. We expect the ramp of 12TB HDDs to be the key focus in the C1Q18 earnings season; a 14TB ramp is likely a late-2018 / 2019 story. As a reminder, we believe the industry will be looking to incorporate heat-assisted magnetic recording (HAMR) and micro-wave assisted magnetic recording (MAMR) technologies at 16TB capacities into 2019.
Wells Fargo Securities, LLC | 15 IT Hardware & Communications Networking Equity Research
F3Q18 Preview: HDD Strength with an Undervalued Flash Business Wells Call: We continue to recommend shares of WDC ahead of the company’s upcoming F3Q18 earnings release (4/26, after market). Driven by expected strong HDD results in 1Q18 (most notably high-cap / nearline enterprise HDDs with estimates of >80% yr/yr capacity ship growth) and our model reflecting WD’s total Flash / SSD capacity shipments declining more than 6% seq. with a blended ASP ($/GB) down over 9% sequentially, coupled with the impact of the company’s debt / interest expense reduction during the quarter, we maintain our F3Q18 estimates at $4.94B / $3.35. This compares to WD’s guide at ~$4.9B / $3.20-$3.30; consensus estimate at $4.93B / $3.30. We model F4Q18 at $5.04B / $3.35 (street: $5.05B / $3.29) with an estimated 41% GM% (note: we reduce our estimated Flash GM% by ~200bps seq. to 52%) and an adequately adjusted interest expense at $107MM (vs. $180MM in F2Q18) to reflect the company’s debt / interest rate reduction (reminder: WD priced its new debt on March 2nd; reducing annum non-GAAP interest expense to $410-$415MM from the prior ~$720MM/annum level). Most importantly, we maintain forward estimates solidly above consensus – C2018: $21.3B / $14.46 (street: $20.5B / $14.09), C2019: $22.4B / $14.39 (street: $21.2B / $12.98), and C2020: $23.0B / $14.62 (street: $21.6B / $12.94). Below (page 3) we include an updated pluggable earnings scenario analysis based on NAND Flash vs. HDD bit and ASP ($/GB) assumptions (sendable upon request) – illustrating an upside earnings scenario at +$16/sh.
What Matters The Most:
1. HDDs vs. Flash – Wells Guesstimates; Quarterly Details Would be Nice: A common point of frustration among investors has been Western Digital’s lack of disclosures between HDDs and Flash across its reported segments (Client Devices, Client Solutions, & Data Center Devices and Solutions). We think incremental disclosures would be applauded. Our F3Q18 estimates reflect: (1) total HDD capacity shipments at ~86.2EBs, or roughly flat sequentially; high-cap / nearline enterprise HDD capacity shipped estimated at ~43-44EBs, or +20% seq. and now surpassing 50% of WD’s total HDD capacity shipped (vs. 36% a year ago). We model total HDD blended ASP ($/TB) at -2% seq. and - 16% yr/yr at ~$30/TB. (2) total estimated NAND Flash capacity shipped at ~8.5EBs, or -6% seq. with a blended ASP ($/TB) declining more than 9% sequentially (note: we view this as conservative - compares to NAND Flash contract pricing declining by ~7% seq. in 1Q18; our tracking of SSD pricing data implies a low single digit seq. pricing decline in 1Q18). We currently model WD’s HDD capacity ship CAGR in the low/mid-teens; Flash capacity shipped growing at a ~40% CAGR; HDD and Flash ASPs ($/TB) declining at 10%-15% and mid-20% CAGR ranges.
2. NAND Flash Supply / Demand and Pricing – 20%-25% yr/yr Flash Price Declines ($/GB) + 40%+ Demand Growth = Support of our High-40% / Low-50% NAND Flash GM% Estimates? Investor sentiment on Western Digital remains hyper-sensitive to NAND Flash industry cyclicality and thus incremental bit supply data points as the industry fully ramps 3D NAND contributions (65% of total NAND Flash bits in 4Q17), looks to adds incremental capacity, and begins to execute on the next technology transitions (96-Layer 3D NAND and Quad-Level Cell, or QLC, 3D NAND). Western Digital has noted that it expects industry bit supply to grow at the high-end of its target long-term model of +35%-45% per annum. Micron slightly tempered its comments on 2018 bit supply growth during its recent earnings call to “somewhat higher than 45%” vs. prior “approaching +50%” forecast. Samsung is currently guiding C2018 bit supply to be ~40% yr/yr. With an expectation of consistent industry supply growth commentary, we believe Western Digital will maintain its guidance of executing on a ~20% per annum cost down / price curve; optimization of bit placement across a broad portfolio remains a strategic focus. We remain positive on the WD / Toshiba joint venture (Flash Ventures) operations, from which we are increasingly focused on the company’s execution on BiCS4 96-layer 3D NAND with sample shipments commencing in the December quarter (well ahead of Micron’s report that it would commence sample shipments of 96-Layer in 2H2018).
3. High-Cap / Nearline HDD Demand; Sustained 10/12TB Share & Share Gains in 4/6/8TB Air- Filled HDDs? When Will MAMR vs. HAMR Matter? As we have previously reported, IDC’s preliminary 1Q18 HDD estimates imply high-cap / nearline HDD capacity shipped totaled 91.7EBs, or up over 20% sequentially and +87% yr/yr (note: this compares to WD’s prior expectation of +60% yr/yr bit shipment growth in 1H2018; +50% yr/yr for the full year). We estimate WD’s high-cap / nearline HDD capacity shipments at ~43.8EBs, up 20% seq. and +82% yr/yr. We will be interested in WD’s comments on: (1) trends in 10TB / 12TB supply vs. demand and industry checks have highlighted supply constraints (some upstream supply chain challenges at WD) through the March quarter, (2) WD’s thoughts on capturing incremental share in 4-8TB air-filled HDDs during 1Q18; we would note that these capacity points accounted for ~39% of total high-cap / nearline HDD capacity shipped in 4Q17 (vs. 10TB+ at ~55% of total capacity – per TrendFocus estimates). (3) WD’s thoughts on the progression toward commercializing its next-generation Micro-Wave Assisted Magnetic Recording (MAMR) based high-cap enterprise HDDs looking into 2019. We think the
16 | Wells Fargo Securities, LLC
IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
competitive positioning / difference between Seagate’s use of Heat-Assisted Magnetic Recording (HAMR) versus WD’s MAMR HDDs will be a focus – i.e., cost differential via aluminum versus glass finished media, incorporating nanoscale laser with the read/write head versus spin-torque technology, and drive endurance / reliability characteristics remain focal points.
4. Enterprise SSDs – Increasing Focus on Competitive Positioning; Share Recapture into Mid/2H2018. Positive overall NAND Flash trends jave overshadowed WD’s share declines in enterprise SSDs over the past several quarters – a trend that we remain focused on as a key areas of needed improvement looking through 2018 and beyond. According to IDC’s estimates, Western Digital exited 2017 with a 10.9% revenue share in enterprise SSDs, a notable decline from the Western Digital + SanDisk having a more than a 28% revenue share in 4Q15. TrendFocus estimates that Western Digital’s capacity shipment share in total enterprise SSDs stood at 11.7% in 4Q17, down from the peak of 23.9% in 3Q16. In 2017 Samsung shipped 18.4x more PCIe enterprise SSD capacity than Western Digital; Intel shipped nearly 8x more capacity than Western Digital. Western Digital’s positioning in the NVMe / PCIe enterprise SSD will be a key focus as we think this remains the market that will exhibit the most price / demand elasticity going forward (note: 70%+ of this market is driven by hyper-scale / cloud demand).
5. Capital Structure / Return Discussion: Western Digital completed the pricing / reduction of its debt in early March – taking its gross debt to $11.4 billion with a 3.6% weighted interest rate with the completed redemption of 10.5% and 7.375% senior unsecured and senior secured notes. The company reduced its annual interest expense to $410-$415MM/annum) from the prior $720MM/annum level. With what we believe to be an attractive debt structure, a debt-to-adjusted EBITDA comfortably below 2.0x, and our expectation of +$3B/annum in FCF generation, we think Western Digital could (or has) become active on return capital via share repurchases.
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ITHardware & CommunicationsNetworking
|Wells Fargo Securities,LLC Western Digital Scenario Analysis Wells Fargo Est. C2018E Pluggable Model C2020E P/E Multiple Scenario EV / EBITDA Multiple Scenario C2020 Est. $ Millions; Except per Share C2017A C2018E Bear Base Bull Wells Est. Implied P/E Implied Stock Price EV/EBITDA Implied Stock Price Calendar 2018 Key Inputs (Red = Plugs) 2017-2020E NAND Flash: Multiple Bear Base Bull Multiple Bear Base Bull Bear Base Bull CAGR% / % NAND EBs Shipped 31.0 41.6 38.8 43.4 45.0 84.5 76.3 6.00x $55 $85 $102 4.00x $40 $60 $70 NAND EBs Shipped - Yr/Yr % 25.0% 40.0% 45.0% 35.0% Yr/Yr - % 28.2% 34.0% 25.0% 40.0% 45.0% 40% 35% 7.00x $64 $99 $119 5.00x $55 $80 $93 Blended NAND $ per TB - Yr/Yr % -35.0% -25.0% -25.0% -20.0% Blended NAND $ per TB $319 $235 $207 $239 $239 $141 $163 8.00x $73 $114 $136 6.00x $70 $100 $116 Does This Make Sense When Considering? Flash Revenue Yr/Yr Growth -18.8% 5.0% 8.7% 55.0% Yr/Yr - % 6% -26% -35% -25% -25% -24% -20% 9.00x $82 $128 $152 7.00x $86 $121 $139 * W. Digital acquired SanDisk for $15.588B total consideration; HDD EBs Shipped - Yr/Yr % 8.0% 15.0% 25.0% 15.0% Flash Revenue $9,879 $9,780 $8,027 $10,373 $10,743 $11,932 $12,445 10.00x $91 $142 $169 8.00x $101 $141 $162 $10.9B excluding cash & marketable securities acquired, or Blended HDD $ per TB - Yr/Yr % -8.0% -8.0% -5.0% -10.0% 11.00x $100 $156 $186 9.00x $116 $161 $185 >6x traling non-GAAP EBITDA. HDD Revenue Yr/Yr Growth -0.6% 5.8% 18.8% 11.6% Hard Disk Drives (HDDs): 12.00x $110 $170 $203 10.00x $131 $181 $208
* W. Digital has a higher contribution of solutions versus trade Total Revenue Yr/Yr - % -9.4% 5.5% 13.8% 31.1% HDD EBs Shipped 306.8 377.2 331.3 352.8 383.5 463.8 466.6 13.00x $119 $185 $220 11.00x $146 $202 $231 NAND sales versus Micron. Flash / Other Gross Margin - % 45.0% 49.0% 51.5% 48.0% Yr/Yr - % 13.0% 23.0% 8.0% 15.0% 25.0% 15% 15% Hard Disk Drive Gross Margin - % 31.0% 32.0% 32.5% 31.0% Blended HDD $ per TB $33 $30 $30.25 $30.25 $31.24 $23 $24.0 Current vs. 5-Yr P/E Multiples Current vs. 5-Yr EV/EBITDA Multiples * We believe W. Digital has executed extremely well / on-track Total Gross Margin - % 36.9% 40.0% 41.2% 39.5% Yr/Yr - % -4.3% -8.6% -8.0% -8.0% -5.0% -11% -10% Current Min Median Max Current Min Median Max with 3D NAND, which will include the progression to 96-Layer (BiCS4) 3D NAND in 2018 Operating Expense - % of Revenue 17.0% 16.0% 15.5% 15.5% Hard Disk Drive Revenue $10,089 $11,337 $10,025 $10,674 $11,981 $10,795 $11,186 W. Digital 6.15x 6.12x 9.22x 13.44x 5.29x 1.51x 5.11x 7.31x * Bain-led consortium to acquire Toshiba Memory Corp (TMC) Average Debt Balance $11,618 $11,386 $11,270 $10,819 Other Revenue $157 $175 $175 $175 $175 $260 260 Seagate 13.09x 6.41x 10.11x 12.60x 8.49x 4.46x 6.58x 8.63x Debt Paydown - % n/a 2.0% 3.0% 3.5% Total Revenue $20,125 $21,292 $18,226 $21,222 $22,899 $22,987 $23,891 Micron 5.28x 4.15x 8.83x 35.16x 3.68x 3.03x 4.31x 6.23x for approximately $18 billion, or nearly 6x TMC's trailing twelve- month operating income (period ending 3Q17). Annualized Interest Rate - % 4.0% 3.6% 3.6% 3.6% Flash / Other Gross Profit $5,211 $5,148 $3,612 $5,083 $5,533 $5,746 $5,973 Average 8.17x 5.56x 9.39x 20.40x 5.82x 3.00x 5.33x 7.39x Tax Rate - % 10.0% 9.0% 9.0% 10.0% Gross Margin - % 51.9% 51.7% 45.0% 49.0% 51.5% 47.1% 48.0% * Based on IDC data, Western Digital's enterprise and client FD Shares Outstanding % Change 2.5% -2.0% -3.0% -2.0% HDD Gross Profits $3,111 $3,611 $3,108 $3,416 $3,894 $3,317 $3,468 Western Digital Sum-of-the-Parts Simple Summary (Using Base Revenue Estimates) SSD revenue totaled $1.67B and $1.72B in 2017 vs. Toshiba Gross Margin - % 30.8% 31.9% 31.0% 32.0% 32.5% 30.7% 31.0% W. Digital HDDs: W. Digital NAND Flash / Other: at $1.16B and $1.16B, represectively. WD's Expectations / Notes: Total Gross Profit $8,322 $8,760 $6,720 $8,498 $9,427 $9,063 $9,441 HDD Revenue $10,674 Flash / Other Revenue $10,373 - CY2018 revenue growth at high-end of +4%-8% yr/yr long-term revenue growth target Gross Margin - % 41.4% 41.1% 36.9% 40.0% 41.2% 39.4% 39.5% HDD GM% 32.0% Flash / Other GM% 49.0% - CY2018 gross margin above long-term target model of 33%-38% (sustainable trend?) Total Operating Expenses $3,307 $3,424 $3,098 $3,396 $3,549 $3,620 $3,703 HDD Opex % of Rev. 16.0% Flash / Other Opex % of Rev. 20.0% - W. Digital has a long-term model target with operating expenses at 14%-16% of revenue % of Revenue 16.4% 16.1% 17.0% 16.0% 15.5% 15.7% 15.5% HDD Depreciation Expense $600 Flash / Other Depr. Expense $271 - FY2018 non-GAAP EPS estimated at $13.50-$14.00/sh. (vs. prior >$13/sh.); excludes debt reduction Operating Income $5,015 $5,335 $3,621 $5,103 $5,877 $5,443 $5,738 Implied HDD EBITDA $2,308 Implied Flash / Other EBITDA $3,279 - W. Digital expects its F2019 tax rate to be at the high-end or slightly above LT range of 7%-12% EBIT - % 24.9% 25.1% 19.9% 24.0% 25.7% 23.7% 24.0% - Seagate EV / EBITDA Multiple* 8.04x - Implied Flash / Other EV/EBITDA Multiple: 4.36x - W. Digital reauthorized share repurchase plan in December; $2.1B in current authorization Depreciation Expense $897 $871 $871 $871 $871 $952 $952 WD's Implied HDD Ent. Value $18,548 WD's Implied Flash / Other Ent. Value: $14,287 - Flash industry bit growth in +35%-45% yr/yr range in 2018 (Micron est. ~50% yr/yr; Samsung at ~40%) EBITDA $5,912 $6,206 $4,492 $5,974 $6,748 $6,395 $6,690 - W. Digital's capital return allocation became unrestricted below 2.0x debt-to-adj. EBITDA. Total Interest Expense + Other $783 $469 $469 $469 $406 $390 $389 * Using Seagate EV/EBITDA Multiple for W. Digital's HDD Business; Implied Flash / Other Multiple - 3D-to-3D NAND Flash cost reductions estimated in 15%-25% range. Pretax Income $4,232 $4,866 $3,152 $4,634 $5,471 $5,054 $5,349 * Excluding $2B in Ripple investment value in Seagate's Enterprise Value - W. Digital reporting that 3D NAND at 70% of bits exiting CY2017; 64-Layer at +90% of 3D NAND Tax Rate - % 8.0% 7.7% 10.0% 9.0% 9.0% 10.0% 10.0% - 96-Layer (BiCS4 ) shipments commenced in mid-December; ramp through 2018. Non-GAAP Income $3,894 $4,490 $2,837 $4,217 $4,979 $4,548 $4,814 - Western Digital has highlighted Quad-Level Cell (QLC, or X4) on roadmap - ahead of competitors? Non-GAAP EPS $12.83 $14.46 $9.13 $14.20 $16.94 $14.63 $16.05 - We expect a focus on improved enterprise SSD positioning / execution / solutions in 2H2018 FD Shares Outstanding 303.0 310.5 310.6 296.9 293.9 311.0 300.0
Wells Fargo Notes / Considerations: - Confidence in normalized GM% is key to investor sentiment; SanDisk non-GAAP GM% averaged 46% for 3-yrs prior to acquisition (range: 42%-51%). We believe the investor fear is that NAND Flash GM% declines to sub-30%. - Key NAND Flash GM% variables: (1) pricing versus production costs ($/GB) declines; implications of yield ramps and next-gen. 3D NAND transitions (2) W. Digital's portfolio mix - embedded / mobile Flash vs. client and enterprise SSDs. (3) vertical integration in enterprise SAS SSDs (vs. Intel Flash) * We will remain focused on W. Digital's commentary on the anticipated ramp of 96-Layer 3D NAND - (1) expected cross over for enterpris SAS SSD integration, (2) a disclosed 35% die size shrink, and (3) checks point to single stack (vs. string stack) - its all about producting at teh lowest $/GB. - SanDisk's standalone quarterly non-GAAP operating expense as a percentage of revenue averaged 21% for the 3-years pre-acquisition. - W. Digital's ability to improve / increase its participation in the enterprise SSD market should be an important focus - TrendFocus data implies W. Digital's eSSD capacity shipped grew 20% yr/yr for TTM ending 3Q17 vs. the market growing at >70% yr/yr; WD capacity ship share in eSSDs declining to sub-13% in 3Q17 vs. 24% a year ago. Research Equity - With it being unlikely that W. Digital would look to take out its 7.4% and / or 10.5% debt in the open market (note: callable in April 2019), we continue to think share repurchases could become a more relevant part of W. Digital's capital allocation strategy. - Investors should consider the significant difference in spot and contract pricing versus WD's pricing trends - e.g., we estimate W. Digital's blended Flash $/GB is in the high-single digit / low-double digit yr/yr range in 2017 vs. avg. 2017 spot and contract MLC / TLC pricing at +23% / +75% and +40% / +74%, respectively. - IDC and DRAMeXchange (TrendForce) data shows NAND Flash blended pricing ($/GB) at +15% for YTD ending 3Q17 - well below the implied spot and contract pricing trends. - We expect positive results / forward comments on high-cap / nearline HDDs during F2Q18 earnings; expect focus on W. Digital's positioning with Microwave-Assisted Magnetic Recording (MAMR) vs. Seagate's Heat-Assisted Magnetic Recording (HAMR) to be increasingly debated through 2018 with productization looking into 2019. Source: Company data, FactSet; Wells Fargo Securities, LLC Estimates
IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
Seagate Technology (STX – $59.64 – Market Perform)
F3Q18 Preview: Strength in Nearline = Anticipated F3Q18 GM% & EPS Upside Our Call: Driven by stronger HDD demand (most notably high-cap / nearline HDDs), we expect Seagate to report F3Q18 upside (reporting 5/1; BMO). Based on our capacity-ship driven model, we increased our F3Q18 estimates to $2.81B / $1.45 versus our prior $2.74B / $1.30 estimate (street: $2.74B / $1.32). With an expectation of stable GM% by segment, we believe Seagate could report a 31%+ GM% (we now model 31.2%; +50bps = $0.05/sh.). We expect Seagate to reiterate is expectation of declining opex to ~$375M/qtr by F4Q18. We adjusted our C2018, C2019, and C2020 estimates from $10.83B / $5.07, $11.04B / $5.14, and $11.44B / $5.50 to $11.13B / $5.51, $11.23B / $5.52, and $11.45B / $5.75, respectively. Our estimates reflect 2017-2020E HDD capacity ship CAGRs at -8% for client (PC) HDDs, flat for client non-compute HDDs, and mid-30% for total enterprise HDDs (-12% in mission-critical; +33% in high-cap / nearline HDDs). Based on our revenue mix we believe investors could gauge an HDD GM% into the 33%-34% range by 2020 (high-20% GM% on client compute and non-compute HDDs and high- 30%/40% GM% on total enterprise HDDs).
As illustrated in our pluggable scenario analysis on page 4, with stabilizing HDD demand (continued strength in high-cap / nearline) and prudent opex management (company expected to reach $375MM/qtr exiting June 2018), leaves us / investors to consider EPS into the ~$6/sh. range – though a level we view as adequately reflected in the current share value (note: shares trading at ~8.3x EV/EBITDA vs. 5-year median at 6.6x; range of 4.5-8.6x).
What Matters Most:
High-Cap / Nearline HDD Visibility; Ongoing 10/12TB Ramp in Focus (see charts below): As we have previously reported, IDC’s preliminary C1Q18 HDD estimates imply high-cap / nearline HDD capacity shipped totaled 91.7EBs, or up >20% q/q and +87% yr/yr. We estimate Seagate’s high-cap / nearline HDD capacity shipments at ~40EBs, +16% q/q and +87% yr/yr. This would imply a slight sequential share loss (+1pp yr/yr). We will be focused on: (1) High-Cap Demand: Seagate noted at an investor conference in late Feb. that demand has remained persistent going into C2Q18; “filling in” for 50%-75% of C2018 thus far. Industry checks have highlighted supply constraints (some upstream supply chain challenges at WD) through C1Q18. (2) Ramp in 10TB / 12TB; 14TB / 16TB Timing: Seagate reported in F1Q18 that its 10TB high-cap HDDs were its leading product revenue SKU, while the company saw sequential volume / revenue growth from its 12TB offerings (small base considered). The company has previously noted it will release 14TB drives in mid-2018 (note: WD launched this week) and 16TB drives by the end of the year. (3) Seagate’s competitive positioning in the 4-8TB nearline market as WD looks to more broadly participate (~40% of total nearline capacity shipped). (4) The competitive positioning of Seagate’s HAMR-based next-gen high-cap HDDs vs. WD’s MAMR-based HDDs – commercialization a 2019 story.
Mission Critical Enterprise Resiliency: IDC’s prelim 1Q18 estimates call for Mission critical enterprise HDDs shipped in the 5.35-5.45MM range (-9% yr/yr at the midpoint); IDC’s estimate for Seagate is roughly in-line with our prior estimates. Our industry conversations have suggested we could see a longer tail in this market for units shipped (~5M/qtr; per conversation w/ system OEMs); albeit a return to more normalized declines in flash / SSD pricing will leave us to question increased rate of adoption for SSDs.
FCF; Capital Allocation: We / investors will be focused on Seagate’s expectation that cash flow from operation will be in $2.0-$2.5 billion range in F2018; capex expected to be <5% of revenue (guided at $120MM in F3Q18). This leaves us increasingly confident in Seagate’s F2018 FCF in the $1.5-$2.0 billion range. Shareholder return will be an ongoing focus the company has returned $1.312B in share repo + dividend on a TTM basis (97% of FCF). We expect the company to be focused on share repo as it does have some near/medium term cash requirements (e.g., ~$1.2B related to its Toshiba investment and ~$600MM of debt due in November 2018).
Model Considerations: (1) GM%: With strong nearline shipments in the March quarter, we will be focused on the potential mix benefit to GM%. Our updated F3Q18 estimates reflect a total enterprise HDD contribution as a percentage of total HDD revenue expanding to ~48%, an increase from our estimate at 43% in F2Q18 and up from 40% a year ago. If we were to hold our GM% by HDD segment flat sequentially, our model would imply a +0.6pp total GM% benefit from a higher enterprise HDD mix during F3Q18. Seagate had guided GM% to be flat sequentially vs. 30.4% in the December quarter. Seagate has previously noted that it HDD business is operating at the high-end of its 27%-33% LT target (we estimate ~40% GM% on enterprise HDDs and 27%-28% of non- enterprise HDDs), though headwinds persist in its Silicon / SSD and systems businesses. (2) We expect
Wells Fargo Securities, LLC | 19 IT Hardware & Communications Networking Equity Research
Seagate to reiterate it target of reaching $375MM/quarter of opex exiting F2018 (June 2018). The company had guided F3Q18 opex to decline 2%-3% seq. to the $378-$382 million range.
Seagate’s Competitive SSD Positioning in Declining Flash Price Environment: Although Seagate now has sub-8% of its total revenue in segments most susceptible to Flash / SSD cannibalization (i.e., 500GB or below 2.5” HDDs and 15k RPM mission-critical HDDs), we think investors will now be focused on the return of normalizing NAND Flash / SSD price declines as broadening the potential of Flash cannibalization going forward. While Seagate now has a supply agreement with Toshiba Memory, we think investors will continue to question Seagate’s ability to gain traction in the SSD market (estimated sub-1% share) vs. vertically integrated vendors, which collectively account for 95+% of the total capacity shipped.
20 | Wells Fargo Securities, LLC
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Seagate Scenario Analysis ITHardware, HDD/SSD, Mobility & Networking Weekly
|Wells Fargo Securities,LLC Wells Fargo Est. C2018E Pluggable Model C2020E P/E Multiple Scenario EV / EBITDA Multiple Scenario C2020 Est. $ Millions; Except per Share C2017A C2018E Bear Base Bull Wells Est. Implied P/E Implied Stock Price EV/EBITDA Implied Stock Price Calendar 2018 Key Inputs (Red = Plugs) 2017-2020E Capacity Shipped - EBs Multiple Bear Base Bull Multiple Bear Base Bull Bear Base Bull CAGR% / % Client 72.0 69.4 61.2 68.4 72.0 55.5 56.0 7.0x $21 $37 $45 4.0x $30 $40 $44 Capacity (EBs) Shipped - Yr/Yr % Non-Compute 101.8 107.8 96.7 106.9 117.0 102.6 154.8 8.0x $24 $42 $51 5.0x $36 $48 $54 Client EBs Shipped - Yr/Yr % -15.0% -5.0% 0.0% -8.0% Mission-Critical Ent. 9.0 8.5 7.7 8.6 9.0 6.2 6.2 9.0x $27 $48 $57 6.0x $42 $56 $64 Non-Compute EBs Shipped - Yr/Yr % -5.0% 5.0% 15.0% 15.0% High-Cap / Nearline Ent. 102.8 163.4 143.9 154.2 164.5 259.4 253.0 10.0x $30 $53 $64 7.0x $48 $65 $73 Mission Critical Enterprise -15.0% -5.0% 0.0% -12.0% Total Enterprise 111.8 171.9 151.6 162.8 173.5 265.6 259.1 11.0x $33 $58 $70 8.0x $54 $73 $83 High-Cap / Nearline 40.0% 50.0% 60.0% 35.0% Total Capacity Shipped 285.6 349.1 309.5 338.0 362.5 423.7 469.9 12.0x $36 $63 $76 9.0x $59 $82 $92 Total Enterprise EBs Shipped - Yr/Yr % 35.6% 45.6% 55.2% 32.3% Revenue - ($MM) 13.0x $39 $69 $83 10.0x $65 $90 $102 Total HDD EBs Shipped - Yr/Yr % 8.4% 18.4% 26.9% 18.1% Client $2,655 $2,357 $1,986 $2,396 $2,522 $1,782 $1,773 14.0x $42 $74 $89 11.0x $71 $98 $111 Non-Compute $3,105 $2,950 $2,507 $2,999 $3,392 $2,590 $3,677 $/EB - Yr/Yr % Mission-Critical Ent. $960 $759 $694 $866 $960 $542 $509 Client HDDs $/EB Shipped - Yr/Yr % -12.0% -5.0% -5.0% -5.0% High-Cap / Nearline Ent. $3,009 $4,201 $3,370 $3,837 $4,237 $5,604 $4,082 Current vs. 5-Yr P/E Multiples Current vs. 5-Yr EV/EBITDA Multiples Non-Compute HDD $/EB Shipped - Yr/Yr % -15.0% -8.0% -5.0% -8.0% Enterprise $3,969 $4,960 $4,064 $4,703 $5,197 $6,145 $4,591 Current Min Median Max Current Min Median Max Mission Critical Enterprise -15.0% -5.0% 0.0% -8.0% Hard Disk Drive Revenue $9,729 $10,267 $8,557 $10,098 $11,111 $10,518 $10,041 W. Digital 6.09x 5.70x 9.22x 13.44x 5.14x 1.51x 5.07x 7.31x High-Cap / Nearline -20.0% -15.0% -12.0% -18.0% Other Revenue $891 $865 $838 $869 $936 $930 $946 Seagate 9.64x 5.74x 9.96x 12.60x 6.85x 3.86x 6.51x 8.62x Total Enterprise HDD $/EB Shipped - Yr/Yr % -24.5% -18.6% -15.6% -20.7% Total Revenue $10,620 $11,132 $9,394 $10,967 $12,047 $11,448 $10,987 Micron 4.46x 4.52x 8.96x n/a 3.10x 3.22x 4.33x 6.23x Total Blended HDD $/EB Shipped - Yr/Yr % -18.8% -12.3% -10.0% -14.4% HDD Gross Profit $3,016 $3,285 $2,567 $3,232 $3,611 $3,366 $3,314 Average 6.73x 5.32x 9.38x 13.02x 5.03x 2.86x 5.30x 7.39x HDD Revenue Yr/Yr Growth -12.0% 3.8% 14.2% 1.1% Gross Margin - % 31.0% 32.0% 30.0% 32.0% 32.5% 32.0% 33.0% Other (Non-HDD) Revenue Yr/Yr Growth -6.0% -2.5% 5.0% 2.0% Flash / Other Gross Profit $167 $151 $42 $130 $187 $171 $189 Total Revenue Yr/Yr - % -11.5% 3.3% 13.4% 1.1% Gross Margin - % 18.7% 17.5% 5.0% 15.0% 20.0% 18.4% 20.0% Hard Disk Drive Gross Margin - % 30.0% 32.0% 32.5% 33.0% Total Gross Profit $3,183 $3,437 $2,609 $3,362 $3,798 $3,537 $3,503 Flash / Other Gross Margin - % 5.0% 15.0% 20.0% 20.0% Gross Margin - % 30.0% 30.9% 27.8% 30.7% 31.5% 30.9% 31.9% Total Gross Margin - % 27.8% 30.7% 31.5% 31.9% Total Operating Expenses $1,661 $1,542 $1,456 $1,535 $1,662 $1,570 $1,538 Operating Expense - % of Revenue 15.5% 14.0% 13.8% 14.0% % of Revenue 15.6% 13.9% 15.5% 14.0% 13.8% 13.7% 14.0% Tax Rate - % 6.0% 5.0% 5.0% 5.0% Operating Income $1,522 $1,894 $1,153 $1,826 $2,136 $1,968 $1,965 FD Shares Outstanding % Change 0.0% -1.5% -3.0% -2.0% EBIT - % 14.3% 17.0% 12.3% 16.7% 17.7% 17.2% 17.9% Depreciation Expense $676 $600 $600 $600 $600 $587 $587 EBITDA $2,198 $2,494 $1,753 $2,426 $2,736 $2,554 $2,551 Total Other Income -$249 -$218 -$218 -$218 -$218 -$200 -$200 Pretax Income $1,273 $1,676 $935 $1,608 $1,918 $1,768 $1,765 Tax Rate - % 3.3% 4.8% 6.0% 4.8% 5.0% 6.3% 6.3% Non-GAAP Income $1,231 $1,596 $879 $1,532 $1,822 $1,656 $1,653 Source: Company data, FactSet; Wells Fargo Securities, LLC Estimates Non-GAAP EPS $4.18 $5.51 $2.98 $5.29 $6.37 $5.75 $5.95 FD Shares Outstanding 295.0 289.5 295.0 289.5 286.2 288.0 277.7
Wells Fargo Quick Thoughts:
Seagate has highlighted ongoing strength in high-capacity / nearline – noting in late February that demand has remained persistent going into the June quarter and “filling in” for 50%-75% of C2018 thus far.
We think investors will be focused on the company’s ability to leverage its new NAND flash supply agreement with Toshiba as it looks to more broadly compete in the SSD industry; however, we think investors will continue to question Seagate’s ability to gain traction in the SSD market (estimated sub- 1% share) vs. vertically integrated vendors, which collectively account for 95+% of the total capacity shipped.
Seagate has noted that 8% of its HDD revenue susceptible to flash cannibalization, though we think investors will now be focused on the return of normalizing NAND Flash / SSD price declines as broadening the potential of Flash cannibalization going forward.
We expect Seagate to maintain a high-28%-33% gross margin; mix shift driven Research Equity
Seagate is targeting $375MM/quarter in opex exiting FY2018 (June 2018 quarter); we do not believe investors should consider further downside from this level.
We think investors will begin to focus on the company’s ability to drive toward $6/sh. earnings power.
We will be focused on Seagate's ability to sustain $1.5-$2.0B+ per annum in FCF; dividend support. We expect the company to be focused on share repo vs. dividend increases.
IT Hardware & Communications Networking Equity Research
Nutanix (NTNX – $54.03 – Outperform)
Nutanix Job Listings Update Nutanix’s job listings totaled 571, up 24 from the prior week and compared to 191 a year ago. The company currently has 270 sales openings, up 2 from the prior week. Nutanix has 149 openings for engineers, up 13 from the prior week (vs. 20 a year ago), while support listings were flat at 36 openings. As a reminder, Nutanix reported that it had exited F2Q18 with 3,233 total employees including 1,606 S&M employees, up from 1,493 and 1,226 in the prior and year-ago quarters. Management continued to note that while it did not meet its hiring goal for the January quarter and plans to continue ramping its salesforce hiring. The figure below highlights Nutanix’s employee job listing trends over the past several months.
Cisco Systems (CSCO – $44.09 – Outperform)
Cisco & China Unicom Intro New Collaborative Products – Industrial Internet Multi-Vendor Segment Routing Cisco and China Unicom announced seven new collaboration products including, Cloud Network Connection, Cloud Networking, Cloud VPV, Cloud Broadband, Unicom Cloud Shield, Intelligent Boutique Video Network, and Boutique Financial Network. Cisco noted that it has been collaborating with China Unicom for two years, targeting at transforming the company’s existing traditional nationwide MPLS VPN network into Industrial Internet with the cloud + network synergy based on segment routing. Cisco noted that this project marks a series of firsts in China, including the first segment routing deployment in a service providers’ backbone network, first case of interconnecting equipment from multiple vendors supporting segment routing, and first case of achieving HA with controllers from multiple vendors. China Unicom’s MPLS VPN backbone network was noted as covering 300 cities with more than 1200 devices. The companies noted that once it is connected with IP RAN/SPDC metro network in the future, there will be tens of thousands of devices.
Cisco notes that it used the ASR 9000 router series as the Provider Edge router, and used its static Segment Routing solution to realize the connection of SRTE. As part of the overall solution, Cisco provided its Network Services Orchestrator (NSO) and WAN Automation Engine (WAE), while the company also participated in activities such as business modeling, equipment configuration, topology information collection and route calculation for Cisco and third-party equipment.
Cisco Introduces New Endpoint and Email Protection Cisco introduced a new cloud-managed endpoint security solution, Advanced Malware Protection for Endpoints, that prevents attacks and helps uncover threats to businesses such as ransomeware. The product protects against fileless attacks including those that reside solely in memory. Cisco Visibility, a new cloud application built into the endpoint console, simplifies and speeds up security investigations allowing analysts to investigate incidents quickly. The product combines threat intelligence from Cisco Talos and third parties with internal security event and alert data. Cisco Domain Protection is a new service that automates the process of using email authentication to prevent phishing by analyzing, updating, and taking action against senders who try and phish company systems. Cisco Advanced Phishing
22 | Wells Fargo Securities, LLC
IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
Protection adds machine learning capabilities to Cisco Email Security to block identity deception attacks by assessing threat posture.
Cisco Improves Webex Cisco announced that they are converging the Cisco Spark and Webex platforms into a new Webex Meetings applications for meetings and a new Webex Teams app for collaboration. Key features of the new products include the fact that all Webex meetings now share a common set of features, all meetings are joinable from either the Webex Meetings application or the Webex Teams applications, and the two applications are now supported by servers in the public cloud and from servers in Cisco’s data centers decreasing latency. Cisco also announced Webex Share, a low-cost and simple way for teams to share content on televisions in meeting places. It utilizes a palm-sized adapter that allows teams to share documents or screens.
Commvault Systems (CVLT – $69.95 – Outperform)
Scality Raises $60 Million in Series E Funding; Focused on Multi-Cloud Data Management Last week Scality, a provider of software for distributed file / object storage and multi-cloud data control, announced an additional $60 million of Series E funding; total raised at $152 million. The round was led by new investor, Habert European Growth Capital, with participation by all existing investors (note: HP Enterprise a prior investor). The company reported that it now has over 200 customers.
A Register article highlighted Scality’s 2017 release of Zenko, the company’s open source public cloud gateway and controller. This Amazon S3-based SaaS solution enables the movement of applications from on-premises to AWS or Azure to be stored in native format. The article highlighted the positioning of this solution of addressing the increasing demand for multi-cloud data management – providing data placement and movement, compliance, cloud brokering, indexing / search, and analytics. An interview with Scality CEO, Jerome Lecat, noted that Zenko instances will be through a SaaS application, Orbit, accessed through a cloud portal. While we will be left to gauge the competitive threat to Commvault, we would note that Mr. Lecat highlighted some of its competitive engagements in 2017 included 180 vs. EMC, 80 vs. NetApp, 56 against Ceph, and 50 against IBM CleverSafe; he did not provide Scality’s win rates.
Commvault Announces Expanded Amazon AWS Data Protection Solutions Last week Commvault announced expanded offerings through the AWS Marketplace, enabling U.S. government agencies, system integrators, and private sector contractors the ability to move, manage, and use cloud-based data and workloads with increased security. The company notes that its Commvault Data Platform enables the reduction of administrative and storage overhead by tiering to the right levels of AWS cloud storage, can alight storage costs to SLA profile of services / applications with automated policy-based data movement / tiering, and provide encryption of data in-flight and at-rest with integrated FIPS certified Commvault encryption software.
Rubrik Announces Plans to Add 50 New Employees in Ireland Last week Rubrik announced that it plans to add 50 new positions in Ireland as part of its continued investment and expansion in Europe. This follows the company recently reporting in February that it was approaching a $300MM bookings run rate (implying a 3x increase from a year ago). At the time, Rubrik reported that it had over 800 employees (up 2x over the prior 6 months). We would note LinkedIn currently list 956 employees.
Commvault Job Listings Update – Lowest Level of Total Listings Since 2011 Commvault’s job listings totaled 47, down 7 from the prior week and vs. 74 entering 2018. We would note this is the lowest level of total listings we have seen since 2011. Commvault had 15 sales openings, 0 openings in professional services, and 8 openings in system engineering. This compares to 20, 0, and 9 openings last week, respectively. Of note, US sales listings stood at 11, down 2 from the prior week and compares to 26 a year ago. Commvault exited the December quarter with total headcount at 2,841 up from 2,796 in the prior quarter. We remain focused on sales capacity additions (>10% y/y in F2017) vs. productivity growth when gauging forward upside potential. The figures below highlight Commvault’s employee job listing trends over the past several months.
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NetApp (NTAP – $68.66 – Market Perform)
NetApp Job Listings Update NetApp’s job listings totaled 323, up 27 from the prior week, vs. 328 entering 2018. The company currently has 64 sales openings, up 4 from the prior week and compared to 95 a year ago. The figure below highlights NetApp’s employee job listing trends over the past several months.
Pure Storage (PSTG – $20.64 – Outperform)
Pure Storage Job Listings Update Pure’s open job listings totaled 159 exiting last week, down 11 from the prior week, with sales listings down 12 from the prior week at 73 openings. Pure lists 24 Account Executive openings, down 4 from the prior week. We would note this includes 3 listing for a dedicated FlashBlade Account Executive – down 3 from the prior week.
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IT Hardware, HDD/SSD, Mobility & Networking Weekly Equity Research
Cray (CRAY – $22.40 – Outperform)
Takeaways from Top500’s Analyzes of DOE CORAL Request for Proposal (RFP) Top500 hosted a podcast discussing key takeaways from the Department of Energy’s CORAL-2 RFP for up to $1.8B of exascale computers. Key takeaways from the discussion are presented below:
They noted that an IBM/Nvidia collaboration would be the frontrunner for at least one of the three potential machines. IBM built two pre-exascale systems, Summit and Sierra, at two of the DOE national labs. We would point out that the original pre-exascale contract for Aurora was won by Cray / Intel.
Likely bidders for the RFP are likely to include: IBM, Intel, Cray, and HPE.
Cray is not beholden to select Intel processors and neither is HPE.
Interconnects: Think Cray could come up with a custom interconnect for the machines, HPE with GenZ consortium leaning to AMD, Intel pitching Omnipath
Top500 views Dell as a potential long-shot, dark horse candidate to win an exascale system.
If Aurora stays as the first exascale system Coral-2 will fund 2, 3, and 4 in a tight timeframe reasserting American excellence in supercomputing. High potential for the US not to have the first exascale supercomputer, China on-track for 2020 and potential 2019.
US set to dominate in total volume of exaflops with a pipeline of exascale machines funded
Mounting interest in AI over the past few years, legitimate national security concern via competition with China.
Benchmarks for program – number of data science and machine learning codes for the program that vendors will have to address, AI not dominant form of benchmark yet but is becoming increasingly important.
Timeline of RFP – responses due May 24th, DOE set to respond five weeks after that, decisions will be made this quarter. Potential mid-June announcement?
Cray Introduces AMD-based CS500; Using AMD for First Time in 5 Years Cray announced that they have added support for AMD chips for the first time in five years. The company’s CS500, an HPC cluster platform line, now supports AMD’s EPYC 7000 processors. The line previously supported three processors: Intel Xeon processors, Intel Xeon Phi processors, or a combination of Intel Xeon and Nvidia Tesla processors. The new EPYC server will be contained in a 2U chassis made up of four dual-socket nodes. Each node will support two PCIe Gen3 x16 slots which are able to yield 200 Gbps worth of Omni-Path or InfiniBand.
Top500 interviewed Chris Lindahl, Cray’s Product Marketing Director, who said that the new EPYC nodes would be geared toward customers with applications that are memory bandwidth bound. The article stated that one of the advantages of the Epyc 7000 chip was that its eight DDR4 channels are faster than Intel Skylake processors which can only support six channels. The servers are expected to be available this summer.
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A NextPlatform article highlighted that Cray has seen demand for Epyc processors from HPC companies where memory bandwidth is the most important factor in the purchase decision; specifically organizations that run computational fluid dynamics. This implies that software suppliers have potentially already ported from Xeon to Epyc. Cray’s machine is agnostic as to which Epyc chips can be used but Mr. Lindahl stated that there is strong interest in the Epyc 7601 which has 32 2.2GHz cores with a 180 watt thermal envelope as well as the Epyc 7501 which comes with 32 cores at 2 GHz ad a thermal envelope of 170 or 155 watts.
HP Enterprise (HPE – $17.29 – Market Perform)
HPE Supplies Three UK Universities with ARM-Powered HPC HPE is supplying three universities in the United Kingdom with HPE Apollo 70 clusters with Cavium ThunderX2 ARM processors. The sale is part of Catalyst UK, a three=year project evaluating the potential of ARM-based supercomputers. The systems will be installed at the University of Edinburgh’s Edinburgh Parallel Computing Center, the University of Leicester, and the University of Bristol. The University of Bristol also has the world’s first ARM-based supercomputer, a Cray CS400. Each of the three systems will have approximately 72 peak teraflops of power and 240 GB/second of memory bandwidth. In the United States, the Los Alamos National lab has been using an ARM based supercomputer for over a year and the Argonne National Lab has a deal with HPE to build a 32-node ThunderX2 computer. As a reminder, Cray announced the availability of an ARM option for its XC50 Supercomputer in November based on Cavium’s second-gen ThunderX2 processor.
Supermicro Computers (SMCI – $17.45 – Market Perform)
Supermicro Announces Expanded Credit Facility to $250MM Supermicro announced that it has closed an expanded new credit facility, replacing the company’s pre- existing $85 million credit facility with a $250 million facility led by Bank of America Merrill Lynch and including commitments from syndicate banks. This new credit facility also provide a conversion opportunity to expand borrowing capacity to $400 million after certain (undisclosed) conditions are met. We would note Supermicro had reported in mid-March at the time of entering into an amended loan agreement with Bank of America Merrill Lynch that it expected to increase the borrowing capacity of a new facility.
While the company’s Nasdaq compliance issues continue to be an overhang on the stock (note: hearing panel date on 4/26), we think investors will be left to gauge the increase in borrowing capacity as a potential indicator of Supermicro’s confidence in forward demand. We believe Supermicro’s manufacturing capacity buildout as part of its previously outlined Supermicro 3.0 target of achieving $5B/annum in revenue over the next few years will be a point of focus. As a reminder, Supermicro recently expanded its San Jose Green Computing Park and headquarters to over 2 million square feet of facilities with the opening of its new Building 22 (vs. approximately 1.5MM a year ago).
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