HDD manufacturers. Plus ça change or the restoration of the fallen?

I've always toyed with idea of a series of posts under the topic "plus ça change" because saying "the more it changes, the more it is the same thing" is a recurring theme in investing.  I originally intended to point out all the nonsense that happens on Wall Street with a current event and compare it to an event of yesteryear.  This post points out instances when this time is different, and the more it changes, the more it is not the same thing.  It can be different this time.  A lot of value investors seem to forget this when they jump head first into a company with the idea that past returns are going to correlate with future returns when a paradigm shift is clearly afoot (photography, video games, books).  It's just too convenient to repeat the clichés and seem like a market maven, so it's not true and people should look for disconfirming evidence.

I quoted Seth Klarman in my last post on patents as I've been rereading Margin of Safety since it's the investment book to end all investment books.  The other month I posted about the hard disk drive makers and how some investors were seeing value in the newly consolidated commodity product.  This isn't a post about the value of the patents laying unexploited on their balance sheets.  Klarman points out something that would later inspire NYC gangsta rapper, David Einhorn to proclaim "things done changed."

As I started the post, the plus ça change concept can be pertinent to investors trying to avoid pitfalls.  Speculative nonsense hasn't changed much.  The more the subject of it changes, the more it is the same thing whether it's internet stocks or hard disk drive manufacturers...in the 1980s!  Fancy the HDD manufacturers being the subject of speculative fervor.  Klarman uses hard disk drive makers as an example of an irrational market:

Speculative activity can erupt on Wall Street at any time and is not usually recognized as such until considerable time has passed and much money has been lost. In the middle of 1983, to cite one example, the capital markets assigned a combined market value of over $5 billion to twelve publicly traded, venture- capital-backed Winchester disk-drive manufacturers. Between 1977 and 1984 forty-three different manufacturers of Winchester disk drives received venture-capital financing. A Harvard Business School study entitled "Capital Market Myopia'? calculated that industry fundamentals (as of mid-1983) could not then nor in the foreseeable future have justified the total market capitalization of these companies. The study determined that a few firms might ultimately succeed and dominate the industry, while many of the others would struggle or fail. The high potential returns from the winners, if any emerged, would not offset the losses from the others. While investors at the time may not have realized it, the shares of these disk-drive companies were essentially "trading sardines." This speculative bubble burst soon thereafter, with the total market capitalization of these companies declining from $5.4 billion in mid-1983 to $1.5 billion at year-end 1984.

Certainly the HDD manufacturers are not being touted in a speculative frenzy these days.  In fact, quite the opposite.  Greenlight Capital's recent shareholder letter not only dabbles in the French language, but discusses their investment in Seagate Technologies (via Marketfolly).  Instead of a bright future, the HDD industry faces a lot of headwinds, and Mr. Market is no fan.  The thesis goes that there are still tons of cash flows that can be siphoned off from the company for several years that are well in excess of the market capitalization.   Also, the market is very consolidated now and nobody is paying attention to sector.  Essentially, this time is different.  Things done changed.  It's 30 years later, but shifts can and do occur in industries.  Greenlight estimates Seagate has $3 in earnings power and considered it a bargain at $16/share.  It's now at $10.  Adib Motiwala does a great job echoing a similar sentiment on Western Digital (via Gurufocus).  It's quite hard to figure out what the future looks like for these companies, so I'm staying away, but they certainly would be cheap if things start to shape up with the consolidation.

When it comes to the HDD industry, it's quite possible that things done changed.  The Horace quote that Ben Graham uses at the beginning of Security Analysis is on the money right here, "many shall be restored that now are fallen, and many shall fall that now are in honor."  One reason is that when it comes to price, the more it changes, the more it is not the same thing.  People probably don't hark back to the 1980's and the HDD industry much, but the historical perspective can show you how things do change, even if it doesn't fit most people's short memory.  The French and Horace speak to two sides of the same coin.  First, recognize and avoid situations where the more it changes, the more it is the same thing, such as patent fever, social media, and coffee.  On the other side, looking at the fallen for what shall be restored can uncover some unloved investment opportunities such as the HDD industry.