Western Digital Looks to Reboot the System

IRVINE — Less than five months ago, Western Digital Corp.’s high ride along Wall Street seemed endless and wild.

Forget that the Irvine drive maker’s biggest rivals were quietly struggling with their own profitability. Forget the warning rumbles from hungry upstarts in Korea and Japan, and their less-expensive lines of products. Forget the cyclical nature of the drive industry, the short life span of its products and the tendency to build more hardware than the market can possibly buy.

It was summer. Investors loved the firm and the stock hit a 52-week high in August, bouncing up to $54 a share. It was a great time to be in charge at Western Digital.

Then, suddenly, things turned sour, from announcements of barely breaking even for the second fiscal quarter to the stock hitting a year’s record low--$17.13 a share--last week.

What has happened to Western Digital over the last several months is a story of a strong company struggling--and, at times, failing--to overcome too many obstacles.

A fickle market. A change in corporate focus. A couple of unexpected lawsuits.

“They are blaming everyone except themselves,” said John Monroe, an analyst for Dataquest. “When things are going well, everyone overlooks these things. But when the market turns and the company isn’t doing so well financially, any problems stand out.”

The drive business has flip-flopped between boom and bust periods for nearly two decades. While the demand for disk drives continues to flourish at a healthy clip, a shift in drive-buying trends has created a global surplus of products.

Admittedly, this has been a rough year for the entire drive community. Micropolis Ltd., a pioneer in the drive field, went out of business last month. Industry leader Seagate Technology Inc. said it plans to write off more than $100 million in restructuring charges this quarter. And fellow market giant Quantum Corp. said it will reorganize its operations at its Colorado-based subsidiary, MKQC, and fire an undisclosed number of employees.

So when Western Chairman and Chief Executive Charles Haggerty warned of lower profits because of “greater than anticipated competitive pressure,” investors panicked.

After all, Haggerty was saying dangerous words, a verbal red flag to anyone familiar with the history of the storage industry. It harkened back to the long-gone 1980s, when price-cutting was the principal tool to gain market share.

The trend seemed contagious. In October, Seagate watched its own stock plummet after reporting that its expected earnings would be off more than 30 cents per share.

Seagate officials attributed the discrepancy to, among other things, charges for the markdown of foreign currency.

At the time, Western Digital staff blamed the industry’s problems--and its own disappointing earnings--on Seagate. Their rival was apparently too optimistic when it originally forecast summer PC demand and made too many of those popular units.

Western’s drop was temporary, staff insisted. It is just Western’s reliance on the desktop that caused the earnings shortfall, as one of its desktop models had become less profitable than it had anticipated.

Then, in November, the blame shifted to Fujitsu Computer Products of America. Haggerty accused the Japanese corporation of spearheading a new round of price-cutting on drives used in personal computers.

“Oh please. We only have about 8% of the market, while Western Digital has at least three times as much,” said Larry Sanders, president and chief executive for Fujitsu. “Besides, we don’t make [the same type of] drives as Western Digital. They’re accusing us of robbing banks we haven’t even entered.”

Then, last week, Western Digital said it would stop making disk drives for computer laptops and notebooks and only break even for the second fiscal quarter--before taking a one-time charge of up to $95 million because of its production changes.

This time, the company blamed price-cutting competitors from Japan and Korea, specifically Fujitsu, Samsung and Maxtor Corp., a unit of Hyundai Electronics Industry Co.

“It’s all true,” Haggerty said.

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But it’s also true that Western Digital, known for its ability to stretch the shelf life of older technology, has been slower than its rivals to adopt new standards.

“Word on the street is they’re sort of a sleeping giant,” said Mike Long, a partner at the market-tracking firm Short Alert, in Charlotte, N.C. “They have solid technology, but they are slow to react.”

Western Digital needs to find a few good niches, said Roger Johnson, former chairman of the Irvine firm and one-time director of the General Services Administration.

“To get through this period, it’s going to require another round of heavy investment in technology, some serious steps toward cost reduction and a look at finding other applications for their products,” Johnson said. “They need something to set them apart. And they need it to happen some time during the next couple quarters.”

No one knows what will set Western Digital out--and preferably ahead--of the pack.

But the company’s plan is to focus on building hard drives for the desktop and further invade the industry’s plum arena: high-end data storage for computer servers.

If a war in market share is being fought, Haggerty said, their forces are gathering in this arena, where the higher-capacity drives command higher profits. Here, the chairman said, is where they hope to enjoy their victory, rather than a consolation prize from the demands of fickle PC manufacturers.

But some see this focus as limiting.

“I think they should be exploring both the very high- and mid-to-lower-end markets,” Johnson said. “There’s room for a lot of growth in that low end, what with the various new storage requirements for the under-$1,000 and $500 computers.”

And the competition at the high end is already fierce, particularly from rivals Seagate, Quantum and Maxtor.

“If you’re Chuck Haggerty, you’re hoping that every other company is scaling back from the PC market as much as you,” said Alexa McCloughan, an analyst with the research concern International Data Corp. “If you’re the competition, you’re seeing an opportunity to take over where Western Digital left, and possibly hit the company when it’s down.”

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It doesn’t help that the company is being distracted by legal troubles, analysts said.

Three former employees contend they were laid off during a round of downsizing last year because of racial, gender and age favoritism.

Last month, two black former employees filed suit against the Irvine firm, with one of the plaintiffs a manager whose photo appeared on the cover of a company employee manual on the diversity of Western Digital’s work force.

A second lawsuit, alleging age and sex discrimination, was filed in July 1996 by former executive Winifred Strohmeyer. She claims the way Western Digital treated--and later dismissed--her led to severe behavior problems in her teenage son, Jeremy. The Long Beach youth was arrested on rape and murder charges last spring in the slaying of a 7-year-old Los Angeles girl in a Nevada casino.

“We have no intention of settling these suits just to get rid of them,” Haggerty said. “Because it is an issue of who is right and who is wrong. . . . We are looking forward to getting [this] out of the way and getting [this] behind us.”

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As Western Digital tries to ride out the current wave of bad news, industry trackers predict the industry will begin to consolidate.

After all, the industry has historically become leaner and much meaner--from about 75 firms in the ‘80s, to fewer than 50 in the early ‘90s, to fewer than a dozen competitors accounting for more than 90% of today’s market.

“We’re not back in the early ‘90s, where you had all these young companies kicking sand at each other in the playground,” Dataquest’s Monroe said. “These are all adult players, all of whom are well funded--would survive. It would be nice to think they will all survive. But I doubt it.”

Given the industry’s history of cut-throat competition, it remains unclear who will survive to be the players a decade from now.

Will it be those firms that rely on outside sources for key components, such as Western Digital and Quantum? Or could it be the businesses that focus on building their strength through being a vertically integrated manufacturer, such as Seagate, IBM and Fujitsu?

“In the long-term, the latter group has an advantage because they have so many resources to pull from,” said Danielle Levitas, a disk drive analyst with IDC. “But speaking generally, there could be room in the market for both kinds of companies.”

That’s what Western Digital hopes. Haggerty insists the key to its future success is to remain flexible, and he admits the company needs to move its products to market faster. By turning a production around quickly, Western Digital said it relies on a “platform” mentality that lets it shift gears to take advantage of the products where the operating margins are higher.

“When you have your inventories inside a [client’s control] like a Compaq or a Dell, and you build all your own parts, you’re only able to draw upon your inventory when it’s being used. . . . That’s too slow, too limiting of a business model to work today,” Haggerty said. “Over time, we’re going to be just fine.”