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EQUITY RESEARCH
NBA 529 SECURITY ANALYSIS
27 April 2003
Maxtor Corporation
TECHNOLOGY
Storage Networking & Services
RISING STAR GAINING MOMENTUM
Stock Rating: BUY We have initiated coverage on Maxtor Corp. with a twelve month price target of $8.
The company has integrated well after its merger with Quantum's Hard Disk Drive
(HDD) business. It has added new products for the enterprise as well as the
desktop market, giving the company an opportunity to regain market share. The
KEY DATA company has also improved efficiency and has enjoyed higher profit margin.
Ticker MXO Industry dynamics are improving. After years of consolidation the HDD industry is now
Stock Exchange NYSE approaching an oligopoly. Remaining competitors are demonstration pricing discipline
and improved profitability and efficiency.
Price (25 Apr 03) $ 5.38
52 Week Range $ 1.77 - 7.03 Attractive market growth opportunities. The increasing popularity of broadband and
high speed wireless network will create more demand for storage. Non-traditional
Price Target $ 8.00
market such as digital video recorder, game console and set-box box are expected to
Mkt Cap $ 1.343 Bil soar.
Sh. Out. 249.7 Mil Maxtor is well positioned to capture this favorable trend.
Inst. Hldgs. 89.20%
Maxtor currently has strong base in desktop market. Their facilities are optimized
for ATA drive production, which is expected to continue to be the mainstream
technology for desktop market as well as non-traditional market.
Maxtor continue to invest in low cost production facilities in China. This will make
Gaurav Gaur give them better higher profit margin given the downward pressure is now
[email protected] reduced.
Gabriel Buerkle The performance between enterprise level HDD and desktop HDD become
[email protected]
narrower. Maxtor is likely to attack the profitable enterprise market with their new
Jimond Wong, CFA serial-ATA drives.
[email protected]
Page 2 Maxtor Corp. 27 April 2003
Table of Contents
I Executive Summary 3
II The HDD Sector and Maxtor's Opportunity 3
- Sector Overview 5
- Industry dynamics 6
- Technologies and Trends 7
- Demand Drivers 8
- Maxtor's Strategy 9
- Risk Factors 10
III Financial Analysis 11
- Quality of Earning / ESOP Impact 11
- Cash Flow Analysis 12
IV Valuation 13
- RIM Valuation and Major Assumptions 13
V Additional Investment Considerations 15
- Recent Price Momentum and Trading Volume 15
- Institutional Holdings 15
VI Appendix 16
- eVal Printouts
- Financial Statements
Page 3 Maxtor Corp. 27 April 2003
I Executive Summary
Initiating Coverage
We have initiated coverage on Maxtor (MXO) with a buy recommendation and a 12
month price target of $8. After the acquisition of Quantum in April 2001, Maxtor
has become the second largest hard disk manufacturer.
The hard disk drive (HDD) industry has been viewed as a capital intensive, highly
competitive with low margins and very short product life cycles. However we feel
that the industry dynamics is now changing. Consolidation has left just seven major
players in the industry and it is moving towards an Oligopoly. The players are
demonstrating improved efficiency and expanding profit margins. They are also
demonstrating pricing discipline, by not getting into a price war.
Industry Demand Drivers
The drivers for new growth will be greater wireless network and broadband penetra-
tion leading to an increase in number of users accessing more data through a broad
range of devices. At the same time the average file size continues to grow.
The non traditional applications of HDD will also fuel growth. Digitization of
consumer products like digital video recorders and gaming consoles will create
demand for greater storage space.
Given the shrinking IT expenses in the enterprise market, products with lower costs
will grab market share.
Maxtor is well positioned
Introducing new products like industry's first 80GB per platter disk drives and
external hard drives like "personal storage devices" will help Maxtor increase its
share in the desktop market. The production of cheap new serial ATA product will
help address the needs of the enterprises with low IT budgets. Anticipated introduc-
tion of a 15,000 RPM drive for the enterprise market will also help Maxtor regain
market share.
The investment in a new 80,000 ft production facility in China will prepare MXO to
be able to meet the increased demand.
Margin Expansion
In 3Q02, Maxtor exited the NAS business and consolidated its desktop drive
manufacturing business into company owned facilities. This coupled with the
introduction of the high margin 80GB per platter hard disk has helped MXO
increase the gross margin to 18%. We expect the margin to grow further with
Maxtor's increase in the market share of the high margin enterprise market and the
consumer electronics market.
Healthy Financials
Maxtor has had negative cash flows for the last ten quarters. However we believe
the worst is behind and MXO will be positive cash flow company for the FY03. Also,
the financial statements have a high quality of earnings. The M-Score for the
company is a negative 3.15, and inventory, receivables, gross margins, SG&A
expense have all moved in the right direction between FY01-FY02. A TATA ratio of
negative 12.9% is also very healthy.
Page 4 Maxtor Corp. 27 April 2003
Valuation
Based on our eVal model valuation, Maxtor's stock price is currently undervalued.
Using relatively conservative growth and profit margin estimates, we arrived at a
target price of $8 per share. During the technology boom, the stock traded as high
as $19, with the maximum earnings of $30M (approximately $.13 per share). Our
earnings estimate for 2003 is almost $140M or $.54 per share. While the
company will not trade at its peek historic multiples with these earnings, we believe
that shares of MXO are still destined for significant appreciation.
Looking Good on Other Criteria
MXO has a high value to price and a price momentum. It has high institutional
holdings, all analyst recommendation revisions have been upgrades in the last six
months and the stock has a positive earnings surprise for 1Q03.
Risks
With nearly 30% of its sales in Asia, Maxtor's sales could be down over the next
quarter due to the outbreak of SARS. Also, the construction of the new facility in
China may be affected. The company has lowered its expectations for the next
quarter due to these reasons. MXO's performance may also be affected by the
lower than expected adoption of broadband and wireless networks.
Page 5 Maxtor Corp. 27 April 2003
II The HDD Sector and Maxtor's Opportunity
Sector Overview
The hard disk drive (HDD) was invented in the 1960s. After decades of advance-
ment, the HDD is a necessity for every computer, housing the operating system,
applications and data. Over the last two years, the HDD has become a critical
component of various consumer electronic products, such as MP3 players, digital
video recorders and game consoles.
Key Segments:
IDC breaks the HDD market into three main segments: desktop, enterprise and
mobile.
Mobile refers to small HDD for mobile equipment such as notebook, MP3 player
and digital camera. This segment represents 16.3% of total shipments in FY2002.
As WiFi technology penetrates the consumer market, demand for WiFi based
devices such as notebooks, PDAs, tablet PCs, and multi-media mobile players will
grow rapidly. This will translate into a higher growth rate for the mobile segment.
Desktop represents 75.0% of total shipment in FY2002. It refers to HDD sold as
OEM for PCs, digital video recorders and game consoles. The desktop PC market
accounts for over 90% of this segment and is expected to grow sluggishly while the
average unit price will continue to face downward pressure. New growth is
expected to come from new applications, such as digital video recorders, set top
boxes and game consoles. The popularity of external HDD is also expected to
improve as the demand for additional storage space and security back-ups
increases. Gross margin for this sector is around 15% - 20% historically.
Enterprise is the smallest segment, which refer to HDD for data-centers, corporate
servers and mission critical servers. This segment can be further divided into low-
end sub-segment which use slower ATA interface and higher-end sub-segment
which use faster SCSI or Fibre Channel interface. Historically, gross margin for ATA
and SCSI/FC drives are around 20% and 30% respectively.
Figure 1: 2002-2006 Revenue Forecast for Hard Disk Drive Industry
Revenue ($M) 2002 2003 2004 2005 2006 02-06 CAGR
Mobile 2,720 2,972 3,356 3,598 3,860 9.1%
Desktop 10,848 10,441 10,984 11,395 11,802 2.1%
Enterprise 4,874 4,444 4,123 4,143 4,385 -2.6%
Non-Traditional 1,228 1,841 2,415 3,406 4,962 41.8%
Total 19,670 19,698 20,878 22,542 25,009 6.2%
% change 0.1% 6.0% 8.0% 10.9%
Source: IDC
Figure 2: 2002-2006 Unit Shipment Forecast for Hard Disk Drive Industry
Units (000) 2002 2003 2004 2005 2006 02-06 CAGR
Mobile 30,307.80 35,050.80 41,772.90 47,343.40 53,083.40 15.0%
Desktop 142,748.40 146,536.50 160,980.10 173,848.10 184,999.30 6.7%
Enterprise 20,690.30 21,941.70 24,450.70 28,162.50 33,746.20 13.0%
Non-Traditional 20,101.00 31,020.40 37,801.50 53,781.40 80,073.70 41.3%
Total 213,848 234,549 265,005 303,135 351,903 13.3%
% change 9.7% 13.0% 14.4% 16.1%
Source: IDC
Page 6 Maxtor Corp. 27 April 2003
Industry Dynamics
Figure 3: 3Q02 Hard Disk Drive Revenue Share by Segment
Source: IDC
The HDD industry has long been viewed as capital intensive, highly competitive, and
marginally profitable . From 1980s to 2003, the industry has gone through a
painful consolidation and the number of manufacturers dropped from over 70 in
1980s to 22 in 1997 to 7 today. Last year, Maxtor acquired Quantum and became
the 2nd largest player while Hitachi acquired IBM's HDD operation and formed
Hitachi Global Storage Technologies.
From Figure 2, we can see that the big three (Maxtor, Seagate and Western Digital)
now control 85% of the desktop market. As IBM is expected to fade away from this
market after acquired by Hitachi, the remaining players will refill IBM's market
share. Maxtor is expected to benefit from this.
On the other hand, Seagate currently dominate the Enterprise market which is solid
foundation in higher end SCSI drives. Maxtor, on the other hand, only has 9% of
this very profitable market. Maxtor's management is taking very aggressive steps
to expand their market share and is determined to own 20% of the market share by
the end of 2003.
The mobile segment is dominated by Japanese firms given their traditional strength
in micro technologies. Hitachi (including ex-IBM) and Toshiba will add up to nearly
90% market share. Maxtor currently has considerable R&D ability in this sector, but
does not have any plans to enter the segment in the immediate future. Since
Maxtor's focus is mainly on desktop and enterprise segments, we will minimize our
analysis of the mobile segment in this report.
Supply Chain
The major HDD makers are now influential to the entire supply chain after the
consolidation cycle. This translates into lower purchasing cost and higher gross
margin. However, this also implies that the HDD markers must carefully manage
their supply chain to ensure adequate raw material to fill their needs. Maxtor
experienced problems with their supply chain after the acquisition of Quantum, but
resolved the issues by the end of FY04.
Relationship with OEMs and distributors
The consolidation also resulted in stronger pricing power. For Maxtor, it now only
has a few consumers that account for around 10% of their total shipment. The
decline in ASP has been much less than expected which has helped HDD makers
successfully defend their profits margin.
Page 7 Maxtor Corp. 27 April 2003
Technologies and Trends
To understand Maxtor's current position and competitive advantage, we must have
a basic knowledge of HDD technologies and its trends. Generally, HDD is evaluated
by three major parameters:
Capacity: The amount of data that can be stored in the HDD. Currently, a
typical desktop HDD has a capacity of 60--80GB while enterprise
grade can reach 640GB. The capacity of HDD is determined by
(1) the capacity of each platter (based on aerial density of the
disks), and (2) the number of platters in each HDD.
Until recently, the mainstream technology for HDD is 40-60GB/
platter. Maxtor has been become the first manufacturer to mass
produce 80GB/platter drives, and other vendors are expected to
follow in C2Q2003. This gives Maxtor room to improve its profit
margins because they are able to produce double the capacity at
less than twice the cost.
For technical reasons, manufacturers currently cannot use 80GB/
platters technology in multi-platter drives, which implies that in
the near term the price of larger capacity drives is expected to
stay at the current level.
Transfer Rate: The speed HDD transfer data between the drive and mother-
board. This rate is mainly determined by (1) the rotation speed of
the disks, and (2) the interface between the drive and mother-
board.
The mainstream rotation speed for desktop is 5,400rpm while
enterprise is 72,00-10,000rpm. It is expected to climb to
10,000rpm for desktop and 15,000rpm in 2003 or 2004.
The mainstream transfer interface for desktops is parallel-ATA,
while enterprise systems mainly use SCSI or fibre channel (FC).
Parallel-ATA has the slowest transfer rate among the three but
account for more than 90% of total shipment. SCSI drives are
much faster and consume less CPU resources, but are a lot more
expensive, and their usage is limited to high-end servers or
datacenters. FC drives only account for a very small portion of
the market currently.
Looking forward, a new interface, serial-ATA, is expected to
replace parallel-ATA and become the standard for desktops, as
confirmed recently by Intel's introduction of serial-ATA enabled
motherboard chipset. Its high performance is also expected to
displace high-end SCSI drives in certain primary storage applica-
tions. IDC forecasts serial-ATA will account for 25% of the
enterprise market.
Stability: Stability is critically important to HDD industry, especially for the
enterprise level. New products must go through a rigorous
testing and certification process by major OEM manufacturers
and distributors. Maxtor has been making progress to enhance
its reliability by adding additional quality control measures in
recent years.
Page 8 Maxtor Corp. 27 April 2003
Demand Drivers
Many industry analysts are not optimistic about the growth of the PC market and
believe that computer component sales growth is also limited. They are also
considering the effects of shrinking corporate IT budgets. We take another view
of the HDD market; we expect the HDD market to grow quickly.
1) Non-traditional applications
Traditionally, the HDD is a component of PCs and servers. Thanks to the
trend of consumer product digitalization, HDD can now fit into more con-
sumer electronic products. Emerging examples are digital video recorders
(DVR), on-demand cable TV, and gaming consoles. These consumer
products are extremely storage hungry, and consumers generally want as
much storage capacity as their money will buy them. For gaming consoles,
the increasingly popularity in networking games and downloadable compo-
nents and files makes the HDD necessary for most gaming console in the
near future.
Looking forward, the introduction of HDTV will stimulate even higher storage
capacity needs and create a continuous demand in the next decade.
Moreover, gaming consoles are also expected to incorporate more computing
and personal computing functions, which will require additional storage
capacity.
2) Wireless Network and Broadband penetration
We consider high speed network, both wired and wireless, to be an important
complimentary to HDD consumption. Figure 4 provides the forecasted
household penetration of broadband access in major economies. We expect
that this upward trend will continue to stimulate storage demand as
consumers download more multimedia to their PCs. At the same time, when
online purchases of digital resources increase, (e.g. eBook, music and
movie), consumers will need a second drive to back up their digital proper-
ties.
On the other hand, we anticipate that WiFi-like technology will outpace 3G
wireless network and attract users to exchange large files frequently. Again,
consumers will need additional storage capacity for those "on-the-go" files,
and we expect the desktop HDD to fully meet their needs.
Figure 4: Forecasted Household Penetration of Broadband Access in Major Economies
70
Northern Europe
60
North America
50 Germany & Switzerland
UK
40
Eartern Europe
30
China
20
10
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Future Media Research Programme - Consumers' Adoption & Use of Online Technology - Global Expert Panel: September 2002
Page 9 Maxtor Corp. 27 April 2003
Maxtor's Strategy
Maxtor is well positioned to capture the following growth opportunities:
1) Capturing Non-traditional Segment
Maxtor's major strength is in desktop segment with parallel-ATA interface.
Its manufacturing facilities are optimized for ATA drive production. The
company is currently investing in a new 80,000ft plant in China to produce
ATA products which will reduce its production costs and increase its
market power. As consumer products are generally more price sensitive, a
low cost production center will enable MXO to capture market share
without compromising profitability.
In addition, their existing production facilities require few changes to
produce serial-ATA products, which are expected to become the main-
stream among consumer electronic products. Maxtor is capable of
fulfilling large shipments within a relatively short time for new applications.
2) Expanding Desktop Market
Although expected PC shipments are slowing down, expansion opportuni-
ties still exist. First, IBM is expected to phase out its desktop market
business and leave its 10% market share for the remaining industry
players. Maxtor has a strong chance to capture IBM's former customers.
Also, Maxtor have already reacted to secondary storage needs. Their
existing products include a series of "personal storage devices" which
essentially are external hard drives with proprietary one-touch buttons.
These devices create are a brand extension for their desktop HDD and
increased the utilization rate of their plant.
3) Attacking Seagate
Through its acquisition of Quantum, a company with a rich SCSI R&D base,
Maxtor now possess the ability to produce higher quality SCSI and Fibre
Channel drives. In 2002, they suffered from a supply chain issue, which
led to a temporary decline SCSI drive shipping volume. Management has
stressed that the issue has been resolved, and we expect Maxtor to regain
its market share during in 2003.
On the other hand, as cost conscious enterprises are seeking to lower
their IT budget, Maxtor's new serial-ATA products are expected to be a
popular solution for lower end enterprise customers. As IDC forecast
serial-ATA will account for 25% of the enterprise market, if Maxtor manage
to capture 20-30% of that portion there will be plenty of growth for at least
the next few years. This will also establish their brand name in the
profitable enterprise market in long run.
Maxtor's management has set an aggressive plan to increase their market
share from 11% in 2002 to 20% in 2003, and we are optimistic about the
plan. We expect that Maxtor will ultimately achieve 30--40% of the market
in the next 5-10 years and bring their blended gross margin above 20%--a
step closer to Seagate's 30% level.
Page 10 Maxtor Corp. 27 April 2003
Risk Factors
Although we remain optimistic towards the existing trends and Maxtor's capability
to capture growth opportunities and maintain healthy profit margins, certain risks
factors (but not limited to) may result in less favorable operating results.
1) The outbreak of SARS and its effect on Asian economies
SARS has slowed down the economic growth of many Asian countries--
including many major consumer markets such as China, Hong Kong and
Singapore. If the situation continues, the sales of PCs and other consumer
products will inevitably be affected. In the short run, the freight cost will also
rise.
On the other hand, Maxtor's supply chain in China could also be damaged if
it relies on a few suppliers for critical parts as SARS spread. In the long run,
unsatisfactory hygienic environment may impose a higher risk factor to their
operation.
2) The response of major competitors
In the current state of oligopoly, we believe the market players will carefully
price the product and avoid a price war which would ultimately damage the
entire industry. However, competitors' response is never predictable. For
example, if Maxtor's aggressive move into the enterprise segment triggered
Seagate to respond with a faster price reduction cycle, the profitability of the
entire industry will be hurt.
3) Slower than expected adoption of broadband and wireless network
As a complementary product to HDD, Maxtor's revenue might experience
slower growth if the adoption to broadband networks is stymied. For
example, a number of WiFi standards are being developed simultaneously. If
standard wars persists, consumers may be reluctant to commit to new
products and their demand for secondary storage might slow down.
Page 11 Maxtor Corp. 27 April 2003
II Financial Analysis
Quality of Earning
Maxtor has healthy financial statements (enclosed at the end of this report) which
show a high quality of earnings. The M-score for MXO is -3.15, well below the limit
for non-manipulators. The company is doing exceedingly well on all of the parame-
ters. A large negative TATA ratio of 12.9% is a very healthy sign for the company.
Figure 5: 8 Factor Beneish Analysis
2002 2001 Manipulators
Days Sales in Receivables Index 0.954 0.877 1.460
Gross Margin Index 0.916 0.483 1.190
Asset Quality Index 1.025 0.414 1.250
Sales Growth Index 1.004 0.895 1.610
Depreciation Index 0.852 0.098 1.080
SGA Index 0.638 -0.110 1.040
TATA (Total Accruals to Total Sales) -0.129 -0.605 0.031
Leverage 1.117 -0.365 1.110
M = -4.84 + .920 DSRI + .528 GMI + .404 AQI + .892 SGI + .115 DEPI-.172 SGAI + 4.679 TATA - .327 Leverage
M-score (8-variable model) -3.15
Note: if M < -2.22, firm is considered less likely to be a manipulator
MXO is also doing well on the other factors used to judge the quality of earnings.
The inventory, receivables and SG&A expenses have reduced relative to the
increase in sales in the FY02. The gross margin has increased and MXO's invest-
ment in Research and Development as a percentage of sales is higher than the
industry average of 9%.
Figure 6: Other QoE indicators
Factor Change
Inventory Change Relative to Sales Change -5.77%
Receivables Change Relative to Sales Change -4.65%
R&D as % of Sales +10.61%
% Increase in Gross Margin +0.89%
SGA Expense Relative to Sales -2.23%
In the recently announced 1Q2003 results, MXO inventory levels went up by 23%
over the last quarter. With SARS and the war on Iraq affecting sales, the company
held back inventory to avoid downward pricing pressure on its products. With
manufacturing levels adjusted this quarter, we expect the inventory levels go back
to normal.
ESOP Impact
We securitized the financial statements and noted that their granted options,
mostly at the high time during the internet boom, has insignificant impact to their
share price because most of them has very high exercise price.
Page 12 Maxtor Corp. 27 April 2003
Cash Flow analysis
The cash flows from operations have been on a downhill journey for the last 10
quarters. The company believes that the cash flow hit its rock bottom in 3Q02. The
TATA ratio of negative 12.9% is healthy, and as a result accruals are not a problem.
The company plans to spend $200 Million over the next five years on the building of
a manufacturing facility in China. However, $160-180 Million is expected to be
spent in the next twelve months. With total current assets exceeding a billion
dollars and cash and marketable securities of over $390 Million, MXO should be
able to meet its capital requirements.
The declining CFO, CFI and CFF suggests that the company has reached a stage of
balance. MXO has rediscovered itself especially after it acquired Quantum in early
2001. MXO introduction of industry's first 80GB per platter drive and the antici-
pated introduction of a 15,000 RPM drive for the enterprise market should help
MXO regain market share. Other innovative products like the Maxtor One touch
should help MXO experience growth in the consumer electronics segment. We
believe will re-generate CFO in the next few years and with moderate outflow for
their next plant construction.
Figure 7: Cash Flow Analysis from 1994-2002
250
200
CFF
150 CFO
CFI
100
Cash Inflow / (Outflow)
50
0
-50 1994 1995 1996 1997 1998 1999 2000 2001 2002
-100
-150
-200
-250
Source: Company
Page 13 Maxtor Corp. 27 April 2003
III Valuation
RIM Valuation and Major Assumptions
Model Summary
Historical Data:
Company Name MAXTOR CORP
Most Recent Fiscal Year End: 12/28/2002
Average ROE (last five years) -41.10%
Sales Growth (last five years) 9.43%
Forecast Data:
Forecast Horizon 10 Years
This Year's ROE 17.44%
Terminal Year's ROE 10.15%
This Year's Sales Growth 6.00%
Terminal Year's Sales Growth 4.00%
This Year's Forecast EPS $0.54
Forecast 5 Year EPS Growth 36%
Valuation Data:
Cost of Equity Capital 11%
Estimated Price/Share $8.10
Estimated Price/Earnings Ratio 15.10
Estimated Market/Book Ratio 3.32
Sales Growth Forecast
MXO reported revenues of $938.9M for 1Q03. Over the last ten year's, MXO's
second quarter revenues are on average 3.7% lower than the first quarter. Industry
projections provided by HDD expert IDC were heavily relied upon for forecasting
Maxtor's sales growth. Uncertainty is much more prevalent this year given the war
and redevelopment situation in the Middle East and the SARS breakout in Asia. As
a result, we used an estimate of -4.5% for 2Q03 and revenues of $896.7M. Maxtor
is currently offering $900M as a low-end estimate. Over the past 6 years, MXO has
generated 54% of its revenue in the second half of the year. This statistic indicates
revenues of 3,990.2M for 2003, which is a YOY increase of almost 6%. This figure
is in-line with the expectations of other covering analysts. For FY04, FY05 and
FY06, we assumed sales growth of 8%, 10%, and 12%, respectively. According to
IDC, the industry is expecting to grow by 6% and 8%, respectively, over the next two
years. We expect MXO's growth to outperform the industry average as the company
gains market share from competitors, who have exited the desktop business, and
as MXO penetrates the enterprise market. Additionally, MXO recently introduced
the 80gig single platter HDD. As sales of this product ramp up and Maxtor exploits
its first mover advantage to penetrate the market, we expect additional revenue
increases.
Cost of Goods Sold
Due to recent operational efficiencies, Maxtor has been able to dramatically
increase its gross margins. Over the past five years, gross margins have fallen
between 8% and 14%. Gross margins for Q103 were 18%. The gross margin is
expected to decrease slightly over the second quarter as a result of increased lift
and freight costs due to SARS, but the margin is expected to increase during the
second half of the year. We used an estimate of 19% for the fiscal year. Addition-
ally, we expect the number to increase over the next couple years as more of MXO's
revenue is generated by the higher margin enterprise line and once the Chinese
manufacturing facility opens in 2004. Profit margins in the enterprise market are
approximately 30%. As more of MXO's revenue is generated in this market, their
Page 14 Maxtor Corp. 27 April 2003
margins should experience a significant improvement. Furthermore, the use of
80gig platters will improve the profit margins in the desktop market. We used
values of 78%, 76%, 75%, and 75% for FY04, FY05, FY06, and FY07, respectively.
The terminal value assumption was 80%--we assumed that pricing pressure and
competition will resume over life of the firm.
R&D
R&D's 5-year historical average as a percentage of sales is 9.6%. We used the
average for '03, while Maxtor will continue to contemplate its role in the mobile
HDD market and as the firm examines potential new products and enhancements.
R&D is the life force of this industry; consequently, we held it at more or less a
constant. In '04, we marginally scaled down the company's investment in R&D with
a value of 9.5% in the terminal year.
Interest Expense
Interest rates are expecting to decrease from their 2002 values. We slightly
lowered the interest expense as a percentage of average debt for FY03. Any
improvement in the U.S. economy will most likely coincide with an interest rate hike.
We assigned a value of 9% for FY03 and trended it upward to 12% in the terminal
year.
Effective Tax Rate
Due to losses over the past couple years, MXO will benefit from a low effective tax
rate. The 1Q03 number, which was 5%, is a good estimate for this year's rate. As
the company begins to earn annual profits, the rate increases, and has a value of
32% for the terminal year.
Operating Cash
The company is currently carrying a large amount of cash on its balance sheet. The
average amount needed to carry out daily operations is approximately 10%. We
scaled the number down from 11.7% in 2003 to 10% in the terminal year.
Page 15 Maxtor Corp. 27 April 2003
InsideAdditional Investment Considerations
V Story Headline
Recent Price Momentum and Trading Volume
Price
V/P Vol TO Mkt Price % FY1 % #FY2
Mom V/P B/P Ltg Vol FROE SUE
Decile Decile Cap Chg Chg Ests
Decile
2 1 9 1321 .97 .45 15.0 2.39 .23 119.76 2.54 80.56 3
From above figures adopted from Parker Center screen, we noted the price momen-
tum is among the best in US stocks, which is accompanied by strong volume. We
expected this trend will continue at least in the next few months as more good news
are resulted from favorable market. This stock has attracted increasing analyst
coverage since 4Q2002.
The stock also had a 25% earnings surprise in the 1Q03 (before amortization of
intangibles and stock options expense which reduces the earnings to $.11 per
share from $.20). The stock fell nearly 10% on 4/23 after the earnings announce-
ment. A reduced guidance for the next quarter also contributed towards the down-
fall. We believe this is a golden opportunity to increase holding in Maxtor.
Institutional Holdings
Institutional holdings for MXO are 89.2%, with Citigroup holding 20% of the stock.
This shows that institutional investors have faith in the stock. This will also stabilize
the stock price in longer term
Page 16 Maxtor Corp. 27 April 2003
InsideAppendix
VI Story Headline
List of Appendices
eVal Model--Profits Forecast
eVal Model