What Does Seagate's Buyout Of Dot Hill Signal For The Flash Industry?

  • Seagate has announced its intended merger with Dot Hill, a manufacturer of hybrid flash arrays.
  • Seagate will pay a huge 88% premium for Dot Hill.
  • What does Seagate's Buyout of Dot Hill portend for the flash storage industry?
Seagate acquires Dot Hill

One of the world’s largest manufacturers of hard disk drives, or HDDs, Seagate Technology (NASDAQ:STX) has announced that it plans to buy Dot Hill, a manufacturer of hybrid flash arrays (storage arrays that incorporate SSDs and HDDs) for $694 million, representing a huge 88% premium to the Dot Hill (NASDAQ:HILL) closing price before the deal was announced. As expected, Dot Hill’s shares shot up by a huge margin-- 86%-- the day after the deal was announced.

Quite naturally, investors must be wondering why Seagate is willing to pay such a huge premium for Dot Hill, and what this portends for the flash storage industry in general.

Flash Storage Market Growing Faster than Expected

The first and most obvious reason why Seagate is willing to fork out such a big premium for the company is because the merger will create considerable cost synergies that will allow Seagate to access Dot Hill’s flash products and expertise at a much lower cost than competing flash array storage makers. Seagate wants to use its HDDs together with Dot Hill’s flash arrays to create low cost hybrid flash/HDD arrays.

The hybrid flash arrays (HFA) and all-flash arrays (AFA) market has actually been growing much faster than earlier projections. IDC pegged the HFA and AFA market by the end of 2014 at $10.0 billion and $1.3 billion, respectively. This in effect means that the flash storage market is currently about one-third the size of the HDD market.

The reason why the HFA market is much bigger than the AFA market lies in one word--cost. HFAs are mostly lots of HDD interspersed with a little flash, albeit with pretty dramatic performance gains. Using SSDs in about 2%-5% of a storage array with the rest being HDD can increase IOPS (input/output operations per second) by 100% while lowering latency by 70%. The high proportion of HDD used in a typical HFA means that the cost of production is much lower than that of AFA. This is significant because even though the price of SSDs has been coming down fast, they were, until quite recently 7-8 times more expensive than HDD, which made storage of large amounts of data on SSDs a very expensive affair for large organizations.

But the price of SSDs has been declining quite dramatically, thanks mainly to improved production processes. The cost per GB of SSDs compared to HDDs is now somewhere in the ballpark of 2:1 or even lower for some manufacturers. It now makes a lot of sense for companies to buy AFAs rather than HFAs since the performance gains to purse AFAs over HFAs is large while the cost vs. performance value proposition that HFA offered has now eroded by a large margin.

Indeed, IDC had earlier predicted that the AFA market would get to $1.6 billion by the end of 2016, which means that the market has exceeded those growth projections and is almost two years ahead of estimates. This has prompted the organization to revise its earlier 2015 sales estimate to $2.24 billion.

What it means for AFA makers

By the end of 2014, the five largest AFA manufacturers included EMC (NYSE:EMC), Pure Storage, IBM (NYSE:IBM), NetApp (NASDAQ:NTAP) and HP (NYSE:HPQ).


Source: Bloomberg

To underline the strength of the AFA market, Pure Storage, which filed for its IPO in April, saw its sales quadruple to $174.5 million in 2014 and expects sales to grow 43% in 2015 to hit $250 million. EMC, the market leader in AFAs courtesy of its 2012 acquisition of Xtreme IO, expects its flash sales to double to reach $1 billion in 2015, which will become the company’s fastest product to reach the $1 billion mark.

You will notice that all these leading AFA makers do not manufacture the SSDs that they use in their AFAs, but rather source them from flash manufacturers such as SanDisk (NASDAQ:SNDK) and Micron (NASDAQ:MU). SanDisk sells more SSD products than Micron, with SSD sales constituting about 27% of its revenue compared to about 6.5% for Micron.

Applied Materials-1

The fast-growing flash market is therefore more likely to have a bigger impact on SanDisk. SanDisk has for a long time been content to make SSDs and sell them to AFA and HFA manufacturers. The storage industry has operated this way for a long time, with some companies making the products and others integrating and selling them to end users.

But SanDisk has finally decided to become a direct manufacturer of AFAs this year when it unveiled its InfiniFlash Series with up to 512 TB storage capacity in March, making it an ideal storage product for enterprises. The product’s pricing of <$1/GB makes it the cheapest AFA product in the market, underlining SanDisk’s superiority in NAND flash technology. Though a company like Pure Storage is a leader in the AFA market, its losses have been widening. In contrast, SanDisk has seen its gross margins improve in tandem with growth in its SSD portfolio. Of course part of the reason why SanDisk is able to manufacture SSD products cost effectively is because it owns its foundries.


Source:Anand Tech


I believe the AFA cards are stacked heavily in SanDisk’s favor, and you can expect the company to rapidly gain market share. SanDisk has the talent and engineering capability to stack large amounts of storage into a single controller using very space-efficient designs. Other companies will try to match SanDisk in price, as Kaminario did a few days ago, and this will most likely lead to an even faster decline in AFA prices and accelerate uptake. But only the strongest will survive in this race to the bottom.

The potential for AFAs to turn around SanDisk’s fortunes is undeniable. With the shares having been cut in half this year, I believe now is a good time to buy them.

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