standard poors

Please see General Disclaimers on the last page of this report.

Current Environment ............................................................................................ 1

Industry Profile ...................................................................................................... 9

Industry Trends ................................................................................................... 12

How the Industry Operates ............................................................................... 19

Key Industry Ratios and Statistics ................................................................... 26

How to Analyze a Technology Hardware Company ..................................... 28

Glossary ................................................................................................................ 33

Industry References ........................................................................................... 37

Comparative Company Analysis ...................................................................... 38

This issue updates the issues dated October 2013. The next update of this combined Survey is scheduled for October 2014.

Industry Surveys Computers: Hardware Angelo Zino, CFA, Information Technology Sector Equity Analyst

APRIL 2014

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S&P CAPITAL IQ INDUSTRY SURVEYS (ISSN 0196-4666) is published weekly. Redistribution or reproduction in whole or in part (including inputting into a computer) is prohibited without written permission. To learn more about Industry Surveys and the S&P Capital IQ product offering, please contact our Product Specialist team at 1-877-219-1247 or visit getmarketscope.com. Executive and Editorial Office: S&P Capital IQ, 55 Water Street, New York, NY 10041. Officers of McGraw Hill Financial: Douglas L. Peterson, President, and CEO; Jack F. Callahan, Jr., Executive Vice President, Chief Financial Officer; John Berisford, Executive Vice President, Human Resources; D. Edward Smyth, Executive Vice President, Corporate Affairs; Charles L. Teschner, Jr., Executive Vice President, Global Strategy; and Kenneth M. Vittor, Executive Vice President and General Counsel. Information has been obtained by S&P Capital IQ INDUSTRY SURVEYS from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, INDUSTRY SURVEYS, or others, INDUSTRY SURVEYS does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Copyright 2014 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. STANDARD & POORS, S&P, S&P 500, S&P MIDCAP 400, S&P SMALLCAP 600, and S&P EUROPE 350 are registered trademarks of Standard & Poors Financial Services LLC. S&P CAPITAL IQ is a trademark of Standard & Poors Financial Services LLC.

INDUSTRY SURVEYS COMPUTERS: HARDWARE / APRIL 2014 1

CURRENT ENVIRONMENT

Mobility to drive hardware, as personal computer spending contracts

S&P Capital IQ Equity Research anticipates a mixed global information technology (IT) spending environment in the near term due to a number of factors, including ongoing declines in personal computer (PC) spending, uneven software spending, a maturing smartphone market, tablets cannibalizing PCs, and the evolution of the cloud cannibalizing software.

We forecast a sluggish IT spending landscape in 2014, as enterprises are hesitating and delaying some projects due to political and economic uncertainty. Softer corporate profits this year could drive more customers towards cost-saving solutions, which we think will lead to greater adoption of the cloud. According to IT research firm IDCs first-quarter 2014 estimates, worldwide IT spending increased by 4% in 2013, following growth of 5.6% in 2012, 5.9% in 2011, and 7.9% in 2010. The growth rate is expected to improve to 4.6% in 2014. Going forward, we expect enterprise software, telecom services, mobility devices, and data centers to witness healthy growth rates due to improving business confidence in developed economies, which can be seen through software upgrades in big data, cloud, and mobile technologies.

While PC spending will continue to decline, in our view, improved mobility spending will drive growth in hardware. In retrospect, Windows 8 failed to drive a PC rebound as low-cost tablets continue to cannibalize in spending terms. According to IDC (November 2013), worldwide device shipments (PCs and tablets) totaled 536 million in 2013, 58% of which were PCs. The PC share is seen declining to 52% in 2014 and to 45% by 2017. While tablet shipments are projected to grow at a 15% compound annual growth rate (CAGR) between 2013 and 2017, PC shipments will see a 1.5% compound annual decline between 2013 and 2018.

By value, worldwide device shipments (PCs and tablets) will grow from $280 billion in 2013 to $301 billion by 2017, implying a 1.8% CAGR. The share of PC value in the total device value shipped is expected to drop from 71% in 2013 to 60% by 2017. The value of PC shipments could decline from $201 billion in 2013 to $179 billion in 2017, implying a compound annual decline of 2.8%. The value of tablet shipments could increase from $79 billion in 2013 to $123 billion in 2017, implying a 12% CAGR. This suggests that

the average selling price of PCs could drop at a slower rate (2% compound annual decline) than that of tablets (3%) between 2013 and 2017. In addition, IDC predicts mobile phone shipments to grow at a 4% CAGR from 1.8 billion in 2013 to 2.2 billion in 2018, whereas smartphone shipments will grow at an 11.5% CAGR from 1.2 billion in 2014 to 1.7 billion in 2018.

PC market in the midst of a secular decline According to IDC (March 2014), worldwide PC shipments will decline about 6% in 2014, following a 9.8% decline in 2013, due to a lack of innovation in the PC segment, as well as rising competition from other devices. Emerging markets, which account for a majority of PC shipments, are being affected by an uncertain economic

Chart 1: WORLDWIDE PC SHIPMENTS, REVENUES AND GROWTH RATES

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WORLDWIDE PC SHIPMENTS, REVENUES AND GROWTH RATES

Source: IDC's November 2013 forecast report.

2 COMPUTERS: HARDWARE / APRIL 2014 INDUSTRY SURVEYS

environment and technological changes. Ultrabooks and mini notebooks failed to lift the PC market, hurt by high pricing points and intense competition from mobility devices. For example, the huge success of the iPad mini has cannibalized Apples own MacBooks, causing Apples underperformance in the PC space.

We think the PC industry is struggling to identify innovations that differentiate PCs from other products and inspire consumers to buy. Although stylish and trendy ultrabooks have the potential to revive consumers interest in portable PCs, they still suffer from too high of a price point. We think the availability of touch glass on a device is highly significant in the new-generation consumer PCs, as Windows 8 operating systems are designed and optimized for touch. Therefore, without touch, the usability of new PCs is severely compromised. We believe that consumers today prefer purchasing lower-cost touch-based tablets and other mobility devices that meet most of their day-to-day needs, thus creating a secular decline in traditional PCs. While we expect ultrabook prices to come down sharply in the coming quarters, we remain cautious on whether price points will be attractive enough to stimulate consumer demand. We think the enterprise segment will hold up better than the consumer segment, driven by ongoing corporate refreshes in emerging markets and greater adoption of Windows 7/Windows 8 ahead of the expiration of support for the widely used Microsoft Windows XP version in April 2014.

For 2014, IDC predicts PC shipment declines in every region of the world: 1.9% in the US, 4.3% in Western Europe, 3.9% in Asia Pacific, 7.1% in Japan, and 4.3% in the rest of the world (ROW). Between 2013 and 2018, it expects global PC shipments to decline overall by 1.5%, compounded annually. It expects annual declines between 2013 and 2017 of 2% in the US, 2.6% in Western Europe, 2.2% in Japan, and 0.5% for ROW, but annual growth of 0.8% in Asia Pacific.

Desktop PC sales could decline faster than that of portable PCs. According to IDC, between 2013 and 2017, shipments of desktop PCs will witness a 2.8% compound annual decline while portables will witness growth of 0.7%. IDC predicts desktop PCs to decline 4.3% in 2014 to 130 million units and portables to decline 3.4% to 172 million. This could lead to a change in the ratio of desktop/portables from 43%/57% in 2013 to 40%/60% in 2017. The decline in desktop PCs is largely attributable to a change in consumers preferences toward touch-based and sleeker products. We expect commercial and gaming segments to absorb most of the desktop purchases going forward. The portables are expected to level out with the stabilization in mini notebooks and moderate growth in ultraslim PCs. Although Windows 8compatible touch-based innovative ultraslim PCs could arouse consumers interest, the higher price point, competition from tablets, and component constraints could act as major hurdles in their widespread adoption.

Smartphones and tablets to rule the hardware space According to IDC, worldwide tablet shipments will grow from 221 million units in 2013 to 386 million units by 2017, translating to a 15% CAGR during that period. By value, tablet shipments will grow at an 11.5% CAGR from $79.4 billion in 2013 to $123 billion in 2017. Worldwide smartphone shipments will grow at a CAGR of 11.5% by value between 2014 and 2018, while worldwide mobile phone shipments will grow at a 4% CAGR by value between 2013 and 2018.

There has been a shift in favor of sub-eight-inch screen size within the tablet arena, driven by lower prices, ability to run smartphone apps and better portability. We think several early

Chart 2: WORLDWIDE TABLET SHIPMENTS AND GROWTH RATES

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WORLDWIDE TABLET SHIPMENTS AND GROWTH RATES


adopters of 10-inch tablets are now shifting towards smaller-screen tablets. Several manufacturers are also introducing tablets at under $100, which is attracting new customers to the tablet space. However, low-priced tablets are expected to have a shorter lifespan, leading to increased replacement cycles. As the market

matures, this could lead to multiple tablets per person.

There has also been an increasing use of tablets in the commercial and enterprise arena. According to IDC, the ratio of consumer/commercial will shift from 88%/12% in 2013 to 78%/22% by 2017. We expect Android to remain the mainstream operating system for tablets, followed by the Apple iOS. The share of Windows and Windows RT is expected to increase steadily over the years. The major vendors like Samsung and ASUStek Computer Inc. will contribute to growth in the Android market. According to IDC projections, shipments of devices with a sub-eight-inch screen size will grow at a 15% CAGR between 2013 and 2017, while those with an above-eight-inch screen size will grow at a 14.7% CAGR. As per IDC, Apple accounted for 34.4% of global tablet shipments in the third quarter of 2013; Samsung, 18.7%; ASUStek, 5.8%; Lenovo 3,2%; Amazon, 2.8%; and others, 35.1%.

We think competition is intensifying among first-tier tablet vendors to release new products. In July 2013, Google launched its second-generation Nexus 7 in the US. In September, Apple launched its next-generation 5S iPhone as well as a more affordable low-end 5C iPhone. In October, Apple announced the release of its fifth-generation iPad Air tablet and next-generation iWork and iLife apps that are available with every Mac and iOS device. In January 2014, Samsung launched Galaxy Tab3 Lite to strengthen its share of the tablet market and, in February, the company introduced its fifth-generation Galaxy S5.

Chart 3: WORLDWIDE TABLET SHIPMENT DISTRIBUTION BY OPERATING SYSTEM

Chart 4: WORLDWIDE MOBILE PHONE SHIPMENTS

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According to IDC, the US accounted for 27% of global tablet shipments in 2013, followed by Western Europe, 21%; Japan, 3%; Asia Pacific, 26%; and the rest of the world (ROW), 23%. Between 2013 and 2017, tablet shipments could grow at a CAGR of 10.5% in the US, 15.3% in Western Europe, 6% in Japan, 16.5% in Asia Pacific, and 18.5% in ROW.

Smartphones have been gradually replacing traditional mobile phones (non-smartphones) over the last few years, and we expect this trend to persist. According to IDC, the ratio of non-smartphones to smartphones could change from 45%/55% in 2013 to 25%/75% by 2017. This implies an annualized decline of 8.7% in non-smartphones between 2013 and 2017 and annualized growth of 11.5% in smartphones between 2014 and 2018. Most mobile phone suppliers are turning their focus to smartphones, as demand is largely driven by replacements by current users as well as first-time users. In addition, declining prices will make smartphones affordable to the middle class, aiding faster penetration. The increased competition within Android-based smartphones will force vendors to demonstrate innovation and product differentiation, and reduce prices. This will contribute to an overall increase in demand for smartphones. IDC reported that Samsung accounted for 31.3% of worldwide smartphone shipments in 2013; Apple, 15.2%; LG, 4.5%; Huawei, 4.8%; Lenovo, 4.7%; and others, 39.5%.

By region, in 2013, North America accounted for 15% of global smartphone shipments; Latin America, 9%; Europe, the Middle East, and Africa (EMEA), 24%; and Asia Pacific, (APAC) 52%, according to IDC. IDC predicts that by 2017, the geographic shipment distribution will shift to 11% North America, 9% Latin America, 21% EMEA, and 59% APAC. This implies that between 2013 and 2017, smartphone shipments will grow at a CAGR of 5.7% in North America, 14.1% in Latin America, 10.4% in EMEA, and 16.8% in APAC.

CHINA AND NON-DEVELOPED REGIONS THE KEY TO HARDWARE GROWTH

We think future demand for hardware devices will be driven by the likes of China, India, Brazil, and other non-developed regions. The developed regions (the US, Japan, and Western Europe) are already showing signs of maturity and high penetration rates. As per IDC estimates, these developed regions accounted for 48% of the $280 billion global device market (PCs and tablets) in 2013, while non-developed regions (APAC and ROW) accounted for the balance. As non-developed regions are expected to grow faster than

developed regions, the distribution of the global device market between developed/non-developed will change to 46%/54% by 2017. In addition, the global device market is expected to increase to $301 billion in 2017, implying a CAGR of 1.8%.

Between 2012 and 2017, developed markets are expected to grow at a CAGR of 2% while non-developed markets could grow at a 5% CAGR. In terms of shipments, IDCs prediction implies that the ratio of developed/non-developed could change from 40%/60% in 2013 to 37%/63% by 2017 for PCs, and from 51%/49% in 2013 to 46%/54% by 2017 for tablets.

Table 5: WORLDWIDE TABLET REVENUE BY REGION

WORLDWIDE TABLET REVENUE BY REGION2011 2012 2013 2014 2015 2016 2017

REVENUES (Billions of dollars)United States 15.7 19.6 22.2 25.8 28.4 29.9 30.5Western Europe 7.5 13.2 18.7 22.0 26.6 30.7 33.9Japan 1.6 2.5 3.7 4.8 5.0 4.8 4.5Asia/Pacif ic (excl. Japan) 8.7 14.2 17.8 20.4 22.5 24.8 26.9Rest of World 5.7 10.6 17.0 20.9 24.6 26.5 27.2

Total 39.0 60.1 79.4 94.0 107.0 116.7 122.9MARKET SHARE (%)

United States 40.1 32.7 28.0 27.4 26.5 25.6 24.8Western Europe 19.2 21.9 23.5 23.4 24.9 26.3 27.5Japan 4.1 4.2 4.7 5.1 4.6 4.1 3.7Asia/Pacif ic (excl. Japan) 22.2 23.5 22.5 21.7 21.0 21.2 21.9Rest of World 14.5 17.7 21.4 22.3 23.0 22.7 22.1

Total 98.0 99.0 100.0 100.0 100.0 100.0 100.0YEAR- TO- YEAR % CHANGE

United States 25.4 13.0 16.2 10.1 5.2 2.2Western Europe 75.9 41.7 17.8 21.1 15.5 10.1Japan 60.6 45.6 30.1 2.8 (3.3) (6.1)Asia/Pacif ic (excl. Japan) 63.5 26.0 14.5 10.2 10.2 8.4Rest of World 87.9 59.8 23.2 17.3 7.8 2.6

Total 54.0 32.0 18.4 13.9 9.0 5.4Source: IDC's November 2013 forecast report.


In addition, IDC predicts that between 2013 and 2018, worldwide mobile phone (smartphone and non-smartphone) shipments will grow at a CAGR of 4%, with a 1.6% CAGR in North America, 2.4% in Latin America, 2.4% in EMEA, and 5.6% in APAC. This suggests that non-developed regions will support most of the growth for hardware going forward. Therefore, we believe that any slowdown in China, India, or other non-developed regions could significantly affect the overall hardware environment going forward.

PC WORLDWIDE MARKET SHARE: THE BIG STAY BIG

According to IDC, worldwide PC shipments totaled 82.8 million units in the fourth quarter of 2013, down 4.9% annually and up 3.6% sequentially. Lenovo Group Ltd. emerged as the top player with an 18.5% market share (up from 16.1% in the fourth quarter of 2012), followed by Hewlett-Packard Co. (HP), at 16.6% (17.3%); Dell Inc., 12.1% (10.9%); Acer Inc., 7.3% (8.1%); and ASUStek, 6.7% (6.4%). Solid product development and channel expansion strategy aided Lenovo to capture higher market share. In addition, Lenovo continues to benefit from a better PC landscape in the Asia-based regions relative to the US and Europe. We think that HP and Dell will witness declining shipments in the EMEA region, stable growth in the US, and improving shipments in India and other developing regions.

Within the US, PC shipments totaled 15.8 million units in the fourth quarter of 2013. HP emerged as the top regional player with a 26.5% market share, followed by Dell, at 23%; Apple, 9.3%; and Lenovo, 10%. HP was also the leader in the year-earlier period.

In response to a declining PC outlook, most vendors are reducing traditional PC/notebook production and turning towards convertibles and all-in-one PCs. Recently, Samsung lowered its notebook shipment goal for 2014 to 7 million units, following slower-than-expected shipments in 2013. Unlike traditional desktop PCs that comprise a separate monitor, system base unit, and power cable, all-in-one PCs utilize a different form factorone that integrates the display and base unit into a common chassis, with the power cable permanently attached to the entire mechanism.

THE SERVER MARKET TO REMAIN MUTED IN 2014

We believe the server market will continue to be adversely affected by ongoing server consolidation, technology transitions, and challenging macroeconomic conditions across the globe. According to IDC (February 2014), worldwide spending on servers totaled $52 billion in 2013. IDC expects this to grow at a 2.1% CAGR between 2013 and 2017. During this period, server unit shipments are expected to grow at a 4.6% CAGR, implying a decline in selling prices.

There is an increasing trend towards form factor specialization in the market as both blade and density-optimized servers outperform the general market. These modular form factors are expected to gain adoption with virtualized environments focusing on blades and large-scale homogeneous environments in data centers focusing on density-optimized servers. As per IDC estimates, the share of bladed server revenue to total server revenue is expected to grow from 17% in 2013 to 18% by 2017. The growth in the cloud computing market is expected to drive growth in microservers. With lower space requirements, improved performance, and greater cost efficiency, microservers are used largely in cloud data centers. In addition, the demand for microservers will continue to be driven by the ongoing buildup of scale-out data centers running multiple workload applications, intending to reduce unutilized processing capacity for lightweight workloads.

We think the increasing pressure on IT budgets will drive IT organizations to leverage the operational benefits of the blade platform, by migrating from a complex heterogeneous legacy server environment to a managed blade environment. The spending for high-end enterprise servers will continue to decline as users continue to migrate to lower-cost modular systems. Overall, we see a muted outlook for the server market near term.

STORAGE & PERIPHERALS: MODERATING GROWTH

The market growth rate for data storage by enterprises (i.e., large organizations, such as corporations and government agencies) was expected to post a 0.1% decline in 2013, year on year, according to IDC. In


2013, enterprise storage revenues contracted due to macroeconomic weakness in both developed and developing economies. We believe all the major segments within enterprise storage system, software, and services will witness modest growth going forward due to improving business confidence in the developed economies. According to IDC estimates, between 2013 and 2017, worldwide enterprise storage revenue is expected to grow at a 3.7% CAGR. However, per IDCs May 2013 forecast, between 2013 and 2017, enterprise storage revenues are expected to grow at a 3.1% CAGR in the US, 1.3% in Western Europe, 9% in Asia Pacific, 1.7% in Japan, 6.5% in Central Europe/Middle East, 4.2% in Latin America, and 3% in Canada. IDC estimates worldwide enterprise storage revenue to grow 3.2% in 2014, 4.1% in 2015, 4% in 2016, and 3.7% in 2017.

According to IDC, worldwide sales of disk storage systems fell 5.6%, year on year, to $7.4 billion in the third quarter of 2013. EMC Corp., the market leader with a 30.6% share in external storage, saw its revenues decline 1.3% during the third quarter. NetApp, ranking second with a 13% share, increased its revenues 5.9%, while International Business Machines Corp. (IBM) was third with an 11% share and witnessed a 6% decline in revenues.

Internal storage declined by 12% during the third quarter while external storage decreased by 3.5%. The decline in the external disk systems market is largely driven by reduced spending in the US, Eastern Europe, and Asia/Pacific (including Japan). However, Latin America, Canada, and Western Europe saw increases in demand during the quarter.

We think a key growth area will be the constant and unabated demand for data storage. IDC estimates that total disk storage capacity shipped in the third quarter of 2013 reached 8.4 exabyte, or EB (1 EB equals 1 billion gigabytes), up 16% over a year ago. While this growth rate was the highest of the prior five quarters, it continued to represent a trend of relatively slow capacity growth.

We believe the domination of massive scale-out storage and the re-emergence of Do-It-Yourself (DIY) storage architectures could hurt storage system demand. We believe that massive scale storage systems will account for a significant amount of storage capacity. Their extremely low price levels will inhibit hardware revenue growth. In addition, companies, which build or move toward building their storage in house, will continue to buy storage capacity either directly through hard disk drive (HDD) and solid-state drive (SSD) manufacturers, or through other channels, but not from storage system suppliers. Hence, this will reduce demand for storage systems.

On the other hand, the rise of content driven enterprise could increase the demand for storage systems. While the aggressive use of virtualization is reducing the rate of growth of servers deployed in data centers, the creation, organization, and distribution of rich content is driving a rapid and sustained increase in storage deployments. We believe the growth of content will lead to greater expansion for mega data centers.

SOLID STATE DEVICES POSE A MAJOR CHALLENGE TO HDD INDUSTRY

We believe that the worldwide hard disk drive market will continue to face significant headwinds, largely attributable to a weak PC market. We believe most of the weakness in the PC market is due to a secular decline caused by the emergence of tablet computers. Accounting for two-thirds of HDD shipments, the PC market is the largest consumer of HDDs. The PC market share of HDD shipments is expected to decline to 50% by 2017. In 2013, HDD shipments declined by 5% from 2012. However, they are expected to grow at a CAGR of 2.8% from 2013 to 2017, a forecast that we believe may prove to be too optimistic.

Given the modest decline in HDD prices, IDC predicts worldwide HDD revenues to grow at a CAGR of 2.3% during 2013 to 2017. According to IDC predictions, between 2013 and 2017, Enterprise storage HDD revenues will grow at a 4.4% CAGR, Personal storage HDD revenues at 11.1% CAGR, and Consumer Electronics HDD revenues at 2.7%, but Desktop PC and Portable PC HDD revenues will decline at CAGRs of 4.1% and 2.2%, respectively. We note that this will significantly change the HDD revenue share by application. Therefore, the shares of Enterprise, PC, and Consumer Electronics in HDD revenues will change from 47%, 45%, and 8%, respectively, in 2013, to 56%, 36%, and 8%, respectively, by 2017. We think the


current weakness in the PC market, driven by a longer replacement cycle, will continue to prevent the HDD industry from experiencing substantial growth.

We think another big headwind for the HDD industry is the substitution of solid-state drives (SSDs) for HDDs in PCs and enterprise data centers. We think that over time SSDs will slowly displace HDDs as the mass storage device used in PCs, driven by SSDs fast performance and application to thinner form factors. Recently, IDC also lowered its HDD shipment forecast for 2013 from 591 million (in its April 2013 forecast) to 548 million (October 2013 forecast) and for 2017 from 643 million (April 2013 forecast) to 612 million (October 2013 forecast). We see even more downward potential from these revised estimates.

While we expect the HDD market to shrink, the SSD market is likely to witness robust growth going forward. The long-term SSD market trends are tied to demand derived from the PC and tablet market. As noted earlier, according to IDC estimates, worldwide device shipments (PCs and tablets) will grow from 536 million units in 2013 to 691 million units by 2017, implying a 6.5% CAGR. In addition, the PC/tablet ratio could shift from 59%/41% in 2013 to 45%/55% by 2017, due to the acceleration of tablet cannibalization of PCs.

Increasing interest in ultrabooks and ultrathin PCs could drive replacement cycles near term. We believe the industry witnessed an attach rate to notebooks of around 20% in 2013. We think this growth will continue with a more than 50% attach rate by 2016. We believe the improving attach rate is supported by benefits such as reduced boot-up time, and improved battery life, speed, and heat dissipation, among other factors. We think the SSD adoption rate at enterprise applications is increasing, driven by higher performance and declining cost of ownership. In addition, we believe the enhanced performance offered by SSDs will present a big opportunity for participants in the cloud and data center arena. An increasing amount of content on the Internet, driven by extensive use of Facebook, YouTube, and Netflix, as well as companies reliance on the Internet for day-to-day activities, will bring pressure to build more data centers. In addition, this will lead to a shift to cloud applications for handling big data, which will increase demand for SSDs going forward.

According to IDC, worldwide SSD shipments will grow from 67 billion units in 2013 to 179.8 billion by 2017, implying a 28% CAGR. During this period, the average selling price is expected to decline from $137 to $95, or a compound annual decline of 8.7%. By value, worldwide SSD revenues will grow at 20% CAGR from $9.2 billion in 2013 to $17.1 billion by 2017. By segment, between 2012 and 2017, client SSD revenues are expected to grow at a 15.6% CAGR, enterprise SSDs at 27.2%, and commercial SSDs at 9.6%. Therefore, the ratio of client/enterprise/commercial is expected to shift from 60%/37%/3% in 2012 to 48%/50%/2% by 2016.

BIG DATA AND THE CLOUD: THE TWO KEYS TO STORAGE GROWTH

We believe that big data provides a key opportunity for storage vendors. As businesses become data-driven, they enter a constant quest for analyzing and storing this data in a cost-efficient manner. Storage has played and will continue to play a pivotal role in big data infrastructure. According to IDC estimations, global storage in big data revenues is expected to grow at a 36% CAGR from $4.09 billion in 2013 to $13.98 billion in 2017. By segment, during 2013 to 2017, disk systems should grow at a 32.6% CAGR, tape automation 14.1%, storage software 33.6%, public cloud storage 40.4%, and storage services 41.5%.

Today, we think that there is a lack of appropriate storage technology to handle big data infrastructure. This makes IT vendors invest heavily in products that address big data market demands. We think that improvements to existing technology and development of new technology will enable more buyers to take advantage of big data technology and services. There is an increasing focus on data unification requiring the storage infrastructure for big data to cater to structured, semi-structured, and unstructured data types. In addition, there is a growing emphasis on in-place analytics, such as the Hadoop Map/Reduce engine that runs where the data lives. Ultimately, the widespread adoption of big data is driven by factors such as scalability, performance, integration, security, and governance requirements. We see spending on big data technology development increasing in the coming years.

We believe that the emergence of cloud computing will shape the future of IT spending. Cloud entails shared access to virtualized resources over the Internet. With increasing content on the Internet, the shift to cloud


computing makes more sense, as it enhances performance in a cost-effective manner. This increases IT spending on cloud technologies. As per IDC, cloud services spending will continue to grow at a double-digit rate over the next few years, gradually accounting for a larger portion of all IT spending. By the end of 2014, such cloud spending is expected to grow by 25%, according to IDC.

Recently, Quanta Computer Inc. announced its plan to expand its operating bases for the cloud computing business. We note that large Internet players such as Google, Amazon, and Facebook are now directly seeking cooperation with Taiwan-based original design manufacturers (ODMs) such as Quanta and Wistron Corp. Inventec Corp. in May 2013 revealed that it would start supplying server products to some of its Internet clients. Foxconn Technology Group constructed a cloud computing R&D center at the Kaohsiung Software Park located in southern Taiwan in 2013. Acer and ASUStek have been pushing forward in marketing hardware/software-integrated cloud computing solutions focusing on educational applications and web storage, respectively, according to the companies. Samsung and Lenovo are collaborating with Taiwan suppliers for cloud computing industry.

INDUSTRY REVIEW AND OUTLOOK

As of mid-April 2014, we had a neutral outlook on the S&P Technology Hardware, Storage & Peripherals sub-industry. We think personal computer (PC) sales will be challenged going forward, hurt by continued cannibalization by lower-priced tablet devices. Personal computers represent a big part of the industry, and global PC unit shipments increased only about 4% in 2009, followed by growth of about 14% in 2010, as tracked by market research firm IDC. PC unit sales were just under 2% in 2011. However, shipments fell 3% in 2012 and witnessed an additional 10% decline for 2013. We forecast that shipments will decline 5% in 2014. Since mid-2010, PC unit sales appear to have suffered from consumers substituting media tablets, which are smaller and less robust than traditional PCs and not generally counted as PCs, for laptop PCs. While this substitution effect may pressure PC sales, the computer hardware industry overall should benefit from the growth in tablets. Also, the growing popularity of robust mobile computing devices stimulates data traffic to be handled by servers, creating another spur to the industry.

We see longer-term fundamentals in the computer hardware industry remaining attractive, albeit with lively price competition and pressure on margins. We think a global need for better computing and communications, especially mobile communications, creates an appetite for a wide range of technology products.

We foresee growing demand for Internet-based computing solutions because they offer companies opportunities to reduce costs and improve customer service. Accordingly, servers and data-center computing hardware should benefit from rising demand. However, we also see price competition in servers. We think that hardware vendors have been seeking to offset the negative impact on profits by offering higher-margin services, software, and storage products.

We see modest growth for the data storage hardware market in the next 12 months. We think demand for data storage will be driven by content digitization of old media such as paper and film, growing popularity of social networking websites, and longer record retention for compliance with government regulations. We believe increased adoption of virtualization software will boost demand in the near term, as data storage systems need to be upgraded to take advantage of the improved efficiency. We think the storage software market will grow at a mid-single digit rate in the next 12 months. Drivers we see include business continuity and disaster recovery efforts, compliance and risk management activities, and the increasing prevalence of data mining and related analytics. We think one of the fastest growing sectors is virtualization software, which helps companies improve efficiencies of existing IT infrastructures and lower operating expenses by allowing servers to run multiple applications, rather than just one. We see a decline in the hard disk manufacturing sector of the industry.


INDUSTRY PROFILE

Computer hardware: an important part of IT spending

Spending on computer hardware, defined as server and client (PCs and workstations) systems, represents about a fifth of the worldwide spending on information technology (IT). More broadly defined to include storage disk systems and tape, peripheral equipment such as printers, and networking equipment, as well as the server and client computer systems, computer hardware is about 40% of total IT spending.

According to market researcher IDC, IT spending totaled roughly $1.5 trillion in 2008, and then fell about 4.5% (in constant currency terms) to about $1.43 trillion in 2009. In 2010, it rose about 11% to $1.59 trillion, surpassing the 2008 level. For 2011 and 2012, the worldwide IT industry grew 5.8% and 5.9%, respectively, in constant currency. As per IDCs February 2014 forecast, IT spending increased by 4% in 2013 to surpass $2 trillion, and will grow by 4.6% in 2014. To put this level of spending in perspective, the worldwide IT market was valued at about $1.0 trillion in 2001 and just $360 billion in 1993.

Widespread use of the Internet stimulated demand for a host of IT-related products and services. While such investments may dip during years of slow economic growth, we think the longer-term outlook remains positive. Because infrastructure development is needed to meet growing demand from new users and for new applications, Internet-related spending should continue to rise.

The computer hardware industry can be divided into two main segments: PCs and servers (ranging up to large-scale systems such as mainframes and supercomputers), with workstations as a minor third category. In 2013, based on estimates from IDC, the value of worldwide PC shipments was about $200 billion, servers were worth about $52 billion, and workstations $6.5 billion, for a total of roughly $260 billion in computer hardware sales. This indicates that computer hardware is a substantial portion (approximately 11%) of about $2.4 trillion spent worldwide on IT in 2013, which includes spending on software and services, and some near-cousins of the traditional computing industry (data storage machines, printers, ATMs and retail kiosks, and other increasingly sophisticated office electronics). While the computer hardware space still remains extremely important, we believe that this figure will continue to decline over time as smartphones and tablets will be the growth engines for the hardware space in the years to come.

PC MARKET SHARE TRENDS

The PC market has witnessed rising concentration of market share among the top vendors. With consistent pricing pressure in the industry, only the fittest PC producers have survived. In 1992, the top 10 worldwide vendors accounted for roughly half of the market. From 1999 through 2002, however, just the top five vendors commanded nearly half (45%) of the market. That level has continued to climb, with the top five accounting for 59% of the market in 2010, 2011, and 2012, based on IDC data. Many industry forecasters have long predicted that the top five vendors may hold 70% of the global PC market in the future.

Based on of worldwide unit shipments, Lenovo Group Ltd. emerged as the PC market leader in the fourth quarter of 2013, with a 18.5% share (up from 16.1% in fourth quarter of 2012), followed by Hewlett-Packard Co. (HP), with a market share of 16.6% (17.3%); Dell Inc., 12.1% (10.9%); Acer Inc., 7.3% (8.1%), ASUStek, 6.7% (6.4%); and others, 39.6% (41.2%).

SERVER MARKETS: VOLATILE AND SHIFTING

The overall server market has been volatile since 2000, when worldwide factory revenues, which had declined in the two previous years, peaked at $60 billion, boosted by the Internet build-out. The market slid in the next two years, however, falling roughly 17% to $50.1 billion in 2001 and another 12% to $44.1 billion in 2001, according to IDC, reflecting a slump in IT spending amid the US economic downturn.


The server market improved from 2003 to 2005, led by demand for volume servers. According to IDC data, worldwide server revenues totaled $46 billion in 2003, $49 billion in 2004, and $51 billion in 2005. Modest increases of about 1% in 2006 (to $52.5 billion) and 5% in 2007 ($55.1 billion) were followed by a decline of some 3% in 2008 (to $53.2 billion) and a decided slump of 19% in 2009 (to $43.2 billion).

Server sales rebounded 11.4% to $48.1 billion in 2010. In 2011, server sales registered a 5.8% increase to $52.2 billion, but fell 1.9% in 2012 to $51.3 billion. In 2013, server sales declined 4.4% to $49.7 billion. S&P Capital IQ expects expansion with IT spending in 2014 and beyond. However, we expect pricing pressure to limit revenue potential in servers in the long run, and submit that this is one factor driving the server makers to try server-plus growth strategies, to coin a phrase, wherein the server is a means to sell

software and services as a total data center package with higher growth and margin potential.

As measured by worldwide server systems factory revenue, HP led the server market in 2013 with a market share of 26.6%, but witnessed a revenue decline of 6.4%, versus an overall market contraction of 4.4%. IBM, the market leader in 2012, lost share of the server market25.6% in 2013, versus 30.3% in 2012as its factory revenue declined by 19.1% for the year. Dell gained share and remained solidly in third place in 2013, with revenue growth of 2.7% and server market share of 16.6%. Oracle, the owner of the

Sun Microsystems server products, continued losing market share in 2013. Cisco improved its position with revenue growth of 38.7% and market share of 4.5% in 2013.

DATA STORAGE: A LARGE AND GROWING INDUSTRY

The data storage industry is a large and growing industry. It is comprised of enterprise storage system providers, including EMC Corp. and NetApp Inc.; IT hardware manufacturers like International Business Machines Corp. (IBM) and Hewlett-Packard Co. (HP), which sell data storage systems along with their servers; and hard disk drive manufacturers such as Western Digital Corp. and Seagate Technology.

Data storage providers: whos who in the storage business The computer storage business is divided into several segments, which are detailed below.

Storage systems. Typically considered at the top of the storage food chain are storage systems vendors, such as EMC, Hewlett-Packard (HP), and IBM, that address the selection, integration, and implementation of most of the components affecting enterprise data storage. In the second quarter of 2013, EMC was the market leader with a 31.3% share. Net App was No. 2 (13.3% share), followed by IBM (12.6%), HP (10%), and Dell (7.6%).

This segment can be further divided by the type of storage system. Typically, application servers will include three or more enclosed mass storage devices. These types of storage are called internal storage and are not designed to be shared with other application servers. All storage systems outside of the server enclosure are called external storage. Often, external storage gets more attention than overall storage systems because it comprises about 70% of the market and is faster growing. We expect this trend to continue, given the increased adoption of cloud computing and the need for networked storage systems. In the third quarter of 2013, EMC was the market leader in external storage with a 30.6% share. NetApp was second (13%), followed by IBM (11.4% share), HP (9.5%), and Hitachi Ltd. (8.3%).

Storage software. Trends such as virtualization are enhancing the role of software for management and security of stored data. EMC, Symantec Corp., IBM, NetApp, and HP are the top five suppliers of storage software, according to the latest available data from IDC. Consolidation in the storage software marketplace

TABLE 6: WORLDWIDE SERVER SYSTEMS FACTORY REVENUE

WORLDWIDE SERVER SYSTEMS FACTORY REVENUE- - - - - REVENUES (MIL. $) - - - - - MARKET SHARE (%)

VENDOR 2012 2013 % CHG. 2012 2013HP 14,149 13,240 (6.4) 27.2 26.6IBM 15,749 12,746 (19.1) 30.3 25.6Dell 8,057 8,275 2.7 15.5 16.6Oracle 2,660 2,329 (12.4) 5.1 4.7Cisco 1,610 2,232 38.7 3.1 4.5ODM 1,790 2,816 57.3 3.4 5.7Others 8,013 8,085 0.9 15.4 16.3

TOTAL 52,028 49,722 (4.4) 100.0 100.0Source: IDC.


has consisted largely of the major players buying smaller, often privately held, companies that have a unique technology or service provided by their applications.

Storage components. In our view, the components space (the underlying technology products that are used to create a networked storage environment) comprises two main categories: host bus adapters (HBAs) and switches. The components side of the business has seen some consolidation: Brocade Communications Systems Inc., a switch maker, merged with McData Corp. in 2007 and acquired Foundry Networks Inc. in December 2008. We note that Emulex Corp. and QLogic Corp. have dominated the HBA market. Cisco Systems Inc., Brocades largest competitor on the switch side, is also a leading supplier of network infrastructure components, which are key to networked storage systems.

Hard disk drives. Despite the increased price competitiveness of flash memory and solid-state drives, the hard disk drive remains the preferred choice for storing mass amounts of data due to its relative high performance and low costs. Currently, the hard disk drive industry is comprised only of five vendors. In terms of unit shipments in 2013, Western Digital was the market leader with about a 45% share, followed by Seagate (40% share) and others (15%).

Enterprise data storage industry According to research firm IDC, the enterprise data storage market, which includes hardware, software, and services, totaled $80.8 billion in 2012, up 4.2% from 2011, reflecting improvement in the global economy.

The improvement in the storage industry was broad-based and spanned all major sectors. The enterprise storage systems segment (recording media and related data system components) increased 4.8% to $35 billion in 2012, after rising 9.2% in 2009. IDC expected to see no growth in enterprise storage in 2013. According to IDC, more than 75% of end-user spending will be on external storage systems, which it expects will grow at a 3.8% compound annual growth rate (CAGR) through 2017. Spending on internal storage will grow at only a 0.4% compound annual growth rate.

Storage software revenues increased 1.1% in 2012 to $14 billion, and were expected to grow by 5.2% to $14.79 billion in 2013. According to IDC, such revenues were projected to grow at a CAGR of 4.9% between 2013 and 2017. Applications like e-mail archiving and deduplication that help customers optimize their environment and reduce overall costs are expected to gain traction. These factors are expected to help this market reach $17.8 billion in 2017, according to IDC.

The worldwide market for storage services increased 5.3% to $31.8 billion in 2012. According to IDCs November 2013 forecast, the market was expected to grow by 5.6% to $33.6 billion in 2013 and to $35.5 billion in 2014. We believe server virtualization and data center transformation will be the catalysts for growth over the next several years.

Although the global economy is improving, we believe critical issues confronting data center operators, such as space constraints and low utilization rates, will get worse. They continue to look for ways to improve performance and efficiency. These demands, along with the need to lower data storage costs by better managing existing assets, have moved server and storage virtualization into the mainstream. The need to improve energy consumption by reducing the number of servers used feeds into the trend of being green, or environmentally friendly, a move that users and investors alike are supporting.

We think that key emerging markets will provide viable opportunities for storage growth. India and China are undergoing expansion that is accompanied by increases in the amount of data requiring storage. In addition, the development of these economies will also bring some form of regulatory compliance, which we think will result in additional revenue opportunities for storage systems. Overall, we continue to see a sustained need for storage solutions, though demand among the various hardware and software components will vary, driven by a combination of regulation, information management, and strategic growth drivers by the user community.


Hard disk drive industry According to IDC, the hard disk drive market totaled $37.5 billion in 2012, up 13% from 2011, reflecting higher selling prices due to consolidation within the industry and following the Thailand floods in late 2011. In 2012, Seagate acquired Samsungs hard disk drive business while Western Digital purchased Hitachis hard disk drive business leaving only three participants in the industry. While fundamentals and prices were extremely strong during the first half of the year, industry conditions began to roll over in the second half due to a decline in the PC market. Risks to the hard disk drive space in the future include more consumers purchasing mobile devices (tablets and smartphones) instead of PCs and greater adoption for solid state devices.

The hard disk drive industry is an oligopoly, comprised of only five vendors. In terms of unit shipments in 2013, Western Digital was the market leader with a 45% market share, followed by Seagate Technology (40% share) and others (15%).

Although just a handful of hard disk drive manufacturers make up the industry, they operate in an intensely competitive market. Hard disk drives differ by storage capacity, form factors, speed performance, and power

usage, but are viewed as commodities because one drive can be easily substituted for another. In addition, the cost of switching between different vendors is low because of standards in the input/output connections. Consequently, the industry has experienced wide swings in pricing due to either an industry supply shortage or overcapacity.

INDUSTRY TRENDS

During each evolutionary phase of the computer hardware industry, the price for computing power has decreased, usability has improved, and the market has broadened. Business spending largely drove growth in computer hardware sales throughout the 1990s. The consumer market became increasingly important during the latter half of that decade, as the Internet boom contributed to rising consumer demand for personal computers (PCs), and that trend has continued. Since 2000, increasing use of computers for audio-visual media is contributing to hardware demand.

Looking back to the 1970s, during the early stages of the industrys evolution, businesses used computers to automate back-office operations such as accounting. Continued advances in technology led to increased computing power, while the size of computers decreased. By the 1980s, computers were small enough to sit on a desktop, and the PC was introduced. Although largely a productivity tool for front-office tasks such as word processing, the new devices also spurred consumer demand for computers.

Network computing, the most recent stage in the computer hardware industrys evolution, has presented a strategic inflection point in the proliferation of PCs and servers. Initially, networked computers attracted a growing base of corporate users. The emergence of the Internet gave this market another shot in the arm and added an unprecedented number of consumers to the mix.

Cloud computingin which users buy processing power as a service via the Internet, rather than having to buy and maintain hardwareis an emerging part of the business. The cloud approach to delivering computing has the potential to offer users a lower-cost alternative and to create a breed of data centers that would cater to cloud users.

Rapid proliferation of the Internet culminated in strong growth for the computer hardware industry in 1999 and most of 2000. However, the industrys fortunes reversed in 2001, and demand remained soft in 2002, reflecting the global economic downturn. From 2003 through about mid-September 2008, the market

Table 7: WORLDWIDE HARD DISK DRIVE REVENUES, BY VENDOR

WORLDWIDE HARD DISK DRIVE REVENUES BY VENDOR- - - - REVENUE (BIL. $) - - - -

COMPANY 2011 2012 % CHG 2011 2012Seagate 11.5 16.3 41.7 34.9 43.4 Samsung 2.4 7.4 Western Digital 9.2 15.1 64.1 27.9 40.4 HGST 5.8 1.5 (74.1) 17.5 4.1 Toshiba 4.1 4.6 12.2 12.4 12.2

Total 33.1 37.5 13.3 100.0 100.0 Totals may not add due to rounding.Source: IDC's August 2013 forecast report.

MARKET SHARE (%)


expanded. Then a global economic downturn knocked information technology (IT) spending down about 4.5% for 2009, with hardware suffering more than software or services. A recovery year in 2010 saw IT spending rise about 8%. Worldwide IT spending continued its growth momentum in 2011 and 2012, with respective overall increases of 5.8% and 5.9%, year on year, at constant currency, according to IDC. However, IT spending increased at a slower growth rate of 4% in 2013.

US PC MARKET GOES FROM BOOM TO MATURE TO BUST

Just when the computer hardware industry was considered mature in the latter half of the 1990s, the industry witnessed a resurgence ushered in by the Internet age. Demand to get onlinecoupled with the proliferation of low-priced (in some cases, even free) PCsbolstered demand in the US through 1999. According to IDC, US PC unit shipments increased by 27% and 24% in 1994 and 1995, respectively. When annual growth slipped to 15% in 1998, many observers concluded that growth in the US was decelerating because of a saturated market. Then, in 1999, US PC shipments surged 25%.

From 2000 through 2002, however, PC sales growth slumped in the US. According to Gartner Inc., an IT market research firm, US PC shipments rose less than 8.0% in 2000, declined approximately 11.0% in 2001, and grew by 4.4% in 2002. Picking up the trail from there, figures from IDC show that US PC shipments grew about 10.8% in 2003, 10.5% in 2004, and 8.5% in 2005. Growth decelerated in 2006, with US unit shipments up only 3.6%. Growth improved in 2007, but only to about 7.6%. Results for 2008 were an increase of only 2.1%, followed by better growth of nearly 8.4% in 2009 and 6.1% in 2010. However, the growth reversed in 2011 and 2012, as US PC shipment declined 4.9% and 7.7%, mostly due to the shift in consumer demand towards lower-priced tablets. In 2013, US PC shipments declined by 2.8%. We expect US PC sales to experience another decline in 2014.

Market concentration, which was becoming evident by the late 1990s, became pronounced with the combination of Hewlett-Packard Co. (HP) and Compaq Computer Corp. in 2002, Gateway Inc.s acquisition of eMachines Inc. in 2004, and International Business Machines Corp.s (IBMs) sale of its PC unit to China-based Lenovo Group Ltd. in May 2005. The consolidation trend continued when Taiwan-based Acer Inc. acquired Gateway Inc. in October 2007. In addition, computer hardware vendors have broadened their product offerings to offset declining margins. These companies are now becoming more focused on cash management and on higher inventory turns and returns on assets.

While the PC industry is certainly maturing, in S&P Capital IQs opinion, there are still geographic areas where PC penetration is well below saturation levels. In addition, the introduction of higher performance products and Internet services (including broadband access) will likely continue to boost demand over the next several years, sustaining unit growth in the high single-digit range over that period.

COMPETITIVE PRICING EVERYWHERE

Several factors have affected computer hardware pricing and sales trends. While chip prices continue to fall and component prices decline steadily, the industrys consolidation has also enabled computer companies to trim operating expenses. Consolidation, however, has also contributed to a more intensely competitive pricing environment that continues to weigh on all computer hardware categories. Vendors try to offset price declines by achieving better volumes via market share gains, and the competitive cycle continues. In the following discussion, we present some context for the pricing pressures at work in the various segments of the computer hardware industry.

PCs. Price competition has been the hallmark of the PC market. One reason is that PCs have become more commodity-like with the standardization of their primary components. Microsoft Corp.s Windows operating system software is used in an estimated 85%90% of PCs worldwide, and Intel Corp.s processors are used in approximately 80%.

Price competition in the PC market became fierce in 1992, when Compaqs price actions precipitated a shakeout among second- and third-tier suppliers. Compaq led the charge again in 1997, dominating the sub-$1,000 PC market at the low end of the market and challenging the price points of direct sellers such as


Dell at the high end. Over the past few years, prices have continued to erode, particularly in the desktop market.

Traditionally, direct sellers have been able to underprice indirect sellers like Compaq and HP, which sell through retail channels. This is because direct sellers yield savings by maintaining low inventory levels. In addition, they do not have to pay the incentives or price guarantees that indirect sellers typically pay resellers. However, many PC makers who sell indirectly are now also using the direct sellers techniquessuch as online order capabilities and build-to-order strategiesto gain efficiencies and narrow price gaps, as well as reduce their cost structures to compete better on price.

Servers. In contrast to the PC market, the explosive growth in servers in the late 1990s attracted new entrants. Lured by growth rates of 25%+ projected for this segment, PC server participants further stimulated the market with dramatic price cuts. Demand also benefited from a technology migration to systems with Intels server-based chips (originally Pentium Pro, followed by Pentium II/III processors and the newer Pentium IV, launched in 2000, and Itanium in 2001) and Microsofts Windows NT Server and Windows Server 2000 operating systems. Windows Server 2003, released in April 2003, witnessed traction with users in 2004, as shipments of paid new licenses for this operating system more than doubled. Additional gains of 23.7% and 13.8% were attained in 2005 and 2006, respectively. Growth slowed in the recession of 200809, but rebounded strongly coming out of the downturn.

Workstations. Growth in this area has been challenged as manufacturers have faced PC-like pricing pressures given the influx of PC-based units. Revenues have also been under pressure as the lower-priced Windows NT workstations have grown at a faster pace than traditional workstations. [Traditional workstations use the Unix operating system and reduced instruction set computer (RISC) microprocessors.]

Large-scale systems. Pricing pressures on large-scale systems like mainframes have been well documented. US businesses are actively moving mainframe applications to other computer platforms, mostly to client/server systems and local area networks (LANs). The competition from the popular client/server and LAN environments has forced mainframe vendors to become more price-competitive. In recent years, however, mainframe makers, led by IBM, have introduced easier, cheaper systems that use complementary metal oxide semiconductors (CMOS). Migration to these new machines should sustain unit growth, partly offsetting the pressure on revenue growth.

THE UPGRADE CYCLE: WINTEL AND BEYOND

Demand for new computers typically accelerates as users migrate to faster processors and/or new operating systems. This is known as the upgrade cycle, a trend that has proven powerful in the PC business. The upgrade cycle assumes that when a new operating system is released, users will trade up to PCs that are more powerful, thus stimulating hardware sales. This happened in 1995, when the introduction of Microsofts Windows 95 caused a surge in PC shipments: in order to handle the new operating system, consumers needed to upgrade to PCs that were more robust.

The upgrade cycle was again apparent in the first quarter of 1997, when US PC shipments grew 20%, the highest year-to-year increase since 1995. This growth was buoyed by migration to MMX (Intels multimedia software instruction set), as well as by a continuing wave of corporate upgrades to Pentium Pro machines with Windows NT.

The combination of Windows operating systems and Intel processors has been nicknamed Wintel. The Wintel dynamic is permeating almost all computer platforms, because of its compelling price/performance compared with the alternative: the reduced instruction set computer (RISC) processor/Unix operating system combination, which had long dominated multiuser systems and workstations.

Another upgrade cycle was launched with Microsofts Windows 2000. However, there was a much more gradual uptake than in prior cycles. The operating system was officially launched in early 2000, but the momentum in user upgrades to the platform was less robust than early predictions. The industry was also expected to witness an upgrade cycle in 2002 with the introduction of Windows XP, which was launched


on October 25, 2001. Both of these upgrade cyclesthe former aimed at the business market and the latter at consumerswere limited by the US economic downturn in 2001 and 2002.

The launch of Vista heralded the next major upgrade from Microsoft. The enterprise version was released in November 2006, and the consumer-based offering debuted in January 2007. Adoption rates were slower than in previous Microsoft upgrades; reasons included mixed reviews of the product and, despite some product enhancements, a lack of compelling new technological features, in our view. The next PC operating system from Microsoft was Windows 7, available since fall 2009. This version has been generally well received and may have released some pent-up demand from PC users who sought to skip the Vista era and thus have aging PCs.

The most recent upgrade from Microsoft was Windows 8, released in October 2012. This is the first Windows operating system that supports touchscreen, and we expect that it will help Microsoft capture market share in the high-growth smartphone/tablet market. This is the first time Microsoft has taken the decision to create an ARM-based version of its Windows operating system and thus break away from the Wintel monopoly. Though Microsoft is the dominant player in the PC market, it has less than 5% share of the smartphone market and a negligible share of the tablet market. By tying up with ARM, which is the dominant player in the smartphone and tablet markets, Microsoft expects to increase its market share in both of these fast growing markets. In September 2013, Microsoft entered an agreement with Nokia Corp. under which it would pay 3.79 billion to purchase substantially all of Nokias Devices & Services business, and 1.65 billion to license Nokias patents. The transaction is expected to close in the first half of 2014, subject to regulatory approvals and other closing conditions. With this transaction, Microsoft aims to accelerate the growth of its share and profit in mobile devices through faster innovation, increased synergies, and unified branding and marketing.

ENTERPRISE DATA STORAGE: THE INTERNET, DIGITIZATION, REGULATION DRIVE DEMAND

The amount of data that enterprises generate is growing at an exponential rate. Business processes that used to be done on paper are being computerized. For example, all modern airplanes are designed using computer-

aided design (CAD) software. This software enables testing to be done in a computer simulation rather than the traditional method of building physical prototypes, resulting in faster analysis and lower production costs.

We think there are several other drivers for the data storage explosion. In addition to the pervasive use of computing technology, we believe the growth of the Internet and e-commerce has increased the need to record data. We also think the increased usage of rich media content, which includes broadcast and shared audio, graphics, and video, has been a major factor for increased demands on data storage.

Globally, we think the growth in emerging markets is also driving the increased need for regulation and oversight, as is the case with the enactment of the Japanese version of Sarbanes-Oxley, which requires firms to submit internal control reports on a

consolidated basis starting with the fiscal years commencing on or after April 1, 2008. The requirements for J-Sox, as it is popularly known, will be modeled on the US version in many ways and thus will require many of the same data storage, archival, and retrieval technologies.

Chart 8: Price per gigabit of data storage

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PRICE PER GIGABYTE OF DATA STORAGE(In dollars)

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We believe that these requirements will boost overall interest in storage-related products because existing levels of capacity are likely to be insufficient to hold ever-expanding quantities of data. Under Sarbanes-Oxley, information needs to be stored for at least seven years. In addition, information must be protected, unaltered, well organized, and easily accessible. The protection aspect is a key component of the new law: it requires that records be stored in an unalterable way in order for them to be certified. Although the overall impact of compliance with these measures is still being determined, it will certainly force IT managers to reevaluate their ability to handle the potential inflow of large quantities of vital information.

Partially offsetting the rapid growth in the demand for enterprise data storage is the price decline in the cost per gigabyte of storage. Most critical data are stored on hard disk drives. Due to new developments in hard disk drive technology, such as perpendicular recording, the aerial density of disk storage devices has increased dramatically, similar to Moores law in computing hardware, thus enabling more data to be stored on the same amount of physical space.

THE MOVE TOWARD NETWORKED STORAGE

Companies have a number of ways to design their enterprise data storage systems. The legacy configuration is a direct-attached storage (DAS). In this configuration, the storage subsystem is directly connected to a general-purpose server. One of the benefits of DAS is its simplicity. It is relatively easy to install and does not have complex interoperability requirements. While the installation is straightforward, DAS can cause bottlenecks because the general-purpose server is burdened with the tasks of locating files on the storage array attached to it. The traffic between various servers and users can also impair transmission speed. Additionally, DAS tends to have lower disk utilization rate because the storage system is often disparate in which storage capacity cannot be shared.

Network-attached storage vs. storage area network There are two main alternatives to DAS: network-attached storage (NAS) and storage area network (SAN). Both of these methods remove the processing of data from the primary company server, thereby allowing for improved network performance and the ability to continue to access information if the server goes down.

In NAS architecture, stored data are attached to the network through a server with a special operating system optimized to provide access at the file level. As a result, NAS takes the processing burden off the server and alleviates some of the data input/output responsibilities. NAS transports data through the Local Area Network (LAN) transports, such as Ethernet. While NAS does not require a separate file transport network, the data transmission rate is bound by the limit of the LAN bandwidth.

Table 9: WORLDWIDE EXTERNAL ENTERPRISE STORAGE SYSTEMS REVENUE FORECAST

WORLDWIDE EXTERNAL ENTERPRISE STORAGE SYSTEMS REVENUES(In billions of dollars)

CAGR (%)INSTALLATION ENVIRONMENT 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 20122017Direct (DAS) 4.54 3.56 3.10 2.77 2.59 2.35 2.23 2.17 2.10 2.05 (4.6)Mainframe netw orked

(ESCON/FICON SAN) 0.79 0.66 0.73 0.89 1.10 1.07 1.04 1.04 1.01 0.99 (1.9)Open netw orked 16.22 14.83 18.68 21.47 22.62 23.36 24.54 25.95 27.33 28.67 4.9

NAS 3.77 3.65 5.44 5.93 6.07 6.24 6.69 7.19 7.68 8.15 6.1SAN 12.45 11.18 13.24 15.54 16.55 17.13 17.85 18.76 19.65 20.52 4.4

Fibre Channel 10.91 9.15 10.25 11.78 12.51 12.81 13.14 13.52 13.89 14.19 2.5iSCSI 1.48 1.85 2.70 3.25 3.47 3.63 3.86 4.20 4.52 4.84 6.8InfiniBand 0.03 0.05 0.13 0.35 0.39 0.45 0.46 0.50 0.56 0.61 9.6Sw itched SAS (SAS SAN) 0.02 0.13 0.15 0.14 0.15 0.14 0.19 0.21 0.23 0.27 12.5Fibre Channel over Ethernet 0.02 0.02 0.03 0.09 0.20 0.32 0.45 0.61 86.6

TOTAL 21.55 19.05 22.51 25.13 26.30 26.78 27.81 29.16 30.45 31.71 3.8Source: IDC's November 2013 forecast report.


SAN is a dedicated network providing storage and backup solutions, and it is on a separate network from the LAN. SAN transports data via Fibre Channel transport, utilizing one of several protocolsFibre Channel, iSCSI, or InfiniBandwhich are described below.

Fibre Channel. Fibre Channel is the primary networking technology used in the storage area network (SAN) environment to transmit data between computer devices. This technology had its origins in the R&D operations of several prominent high-tech companies. Fibre Channel has become the dominant transmitter within SANs because of its ability to address the limitations of the previously adopted technology, small computer systems interface (SCSI).

SCSI is a short-range protocol that links host computers with storage devices. Although it was suitable for managing basic configurations, it was not designed for networking multiple server connections. In addition, SCSI suffers from limitations related to distance, speed, and scalability: it can extend up to 25 meters and scale a maximum of 16 devices. In contrast, Fibre Channel can reach up to 10 kilometers and connect thousands of devices. Moreover, Fibre Channel operates at a much faster rate than SCSI.

iSCSI. After emerging as an alternative to Fibre Channel networking, Internet small computer systems interface (iSCSI) has become the fastest growing interconnect method for networked storage systems. iSCSI is an Internet Protocolbased standard for linking storage devices over a network. Keys to the growth and adoption of iSCSI include the desire for a lower-cost, less complicated networking infrastructure from small and medium-sized businesses, and larger companies need to aggregate stranded servers and provide remote office networking.

Over the last several years, impediments to the adoption of iSCSI have included the lack of promotion by vendors with large installed bases of Fibre Channel SANs, as well as ignorance on the part of customers about the tradeoffs involved. Server virtualization is considered to be the application that can drive increased iSCSI implementation, especially for small and medium-sized businesses. Additionally, as 10 gigabit Ethernet proliferates in the interconnect marketplace, it will drive some market share away from Fibre Channel SAN to iSCSI SAN, in our opinion.

InfiniBand. This increasingly popular interconnect technology is used in high-performance computing environments to deliver high data rates. While Gigabit Ethernet is still the leading interconnect technology, InfiniBand has continued to gain share as a preferred interconnect technology, at the expense of some more widely used solutions in the data center, according to IDC. As the rollout of 10 gigabit (GB) Ethernet continues to experience delays, InfiniBand appears to be gaining favor in the high-performance computing (HPC) arena.

THE EVOLUTION OF THE DATA CENTER

The way we compute has evolved through the years. During the 1970s and 1980s, the dominant computing platform was the mainframe computer. Mainframes were the most powerful computers available, but were expensive. They also required a special environment in which to operate. Since all of the computing was done at a central location, it was also called centralized computing. Companies ran multiple applications on a single mainframe machine to maximize their return on investment. It was common to find mainframes with peak utilization rates of over 90%.

The mainframe computers were displaced in the late 1980s and early 1990s with the rise of personal computers and low-cost servers, which established the model of distributed computing. Personal computers were cheap and could be deployed anywhere. Departments and other subgroups could purchase them and develop applications outside the control of a centralized IT environment. Consequently, most software applications were developed without any standard process and followed a one-application-to-one-server model.

As applications become more mission-critical, the servers were moved into formal data centers. A data center is a facility used to house computers, networks, and storage systems. It generally includes redundant or backup power supplies, redundant data communications connections, air conditioning, and fire


suppression and security devices. It also contains automated systems that constantly monitor server activity, web traffic, and network performance.

The number of servers has proliferated, as more software applications are written. Each new application would require at least one additional server. More would be required if a company planned to develop and test each application on a separate server. The growth in the number of servers has been accelerated by the rise of the Internet.

The task of managing a data center has become increasingly difficult. Many data centers have simply run out of space. Another problem has been rising energy costs, which typically account for 40% of the cost of operating a data center. These two issues have been exacerbated by the fact that most servers are only utilizing a fraction of their processing power. Data center operators describe the condition of having a large number of servers running at very low utilization as server sprawl.

Virtualization can alleviate server sprawl by consolidating many different types of workloads and operating systems onto virtual environments, all running on a single hardware platform. Using servers more efficiently involves fewer processing cycles; this, in turn, reduces cooling and ventilation requirements, along with energy usage. These benefits are consistent with the drive to be green, or environmentally friendly.

HARD DISK DRIVES VS. SOLID-STATE DRIVES

Hard disk drives, which store data magnetically on rotating rigid platters on a motor-driven spindle, offer several key advantages over other forms of electronic data storage. They can provide high storage capacity at relatively low costs and offers relative high-speed performance.

An alternative to hard disk drives (HDDs) is solid-state drives (SSDs). Solid-state drives record, store, and retrieve digital data using integrated circuits (ICs) rather than magnetic. Because they do not have any moving parts, solid-state drives have faster read/write speeds. They also generate less heat and have lower power consumption. Solid-state drives can come in smaller form factors than hard disk drives. However,

solid-state drives are currently much more costly per GB and are available in much lower capacity points than hard drives.

In our view, SSDs will hurt sales of HDDs over time, but not so much as to prevent growth of HDDs. We see increased usage of SSDs in devices in which the advantages of SSDs, such as lower power consumption and smaller form factors, outweigh its main disadvantage, its price. Thus, we believe SSDs will make inroads in Ultrabooks, tablet computers, smartphones, and other mobile consumer electronic devices. However, we believe hard disk drives will remain the preferred choice of storing data on desktop computers, gaming consoles, set-top boxes, and personal/digital video recorders because power consumption and form factor are not major considerations for these devices.

We also see SSDs targeting enterprise applications, where the value proposition is based on cost per transaction or cost per I/O (input/output), rather than on cost per megabyte. Several smaller companies, like STEC Inc., are targeting enterprise applications. We think the demonstration of viability and the adoption of these products could lead to widespread development of enterprise SSDs by the major disk drive manufacturers.

CHART 10: WORLDWIDE SOLID STATE DRIVE SHIPMENTS AND REVENUES

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2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Shipments (left scale) Revenues (right scale)

Source: IDC's May 2013 forecast report.

WORLDWIDE SOLID STATE DRIVE SHIPMENTS AND REVENUES

(Bil.$)(Millions of units)


HOW THE INDUSTRY OPERATES

The modern computer hardware industry began in the early 1980s with the introduction of the personal computer (PC). Before then, computing was dominated by mainframes from International Business Machines Corp. (IBM) and confined mostly to computer professionals and scientists.

The Altair 8800the first commercially successful PC in the early 1970sspawned much of what is thought of as modern computing. In a general sense, the Altair 8800 provided the seeds for the eventual introduction in 1981 of IBMs PC. In a more narrow sense, the Altair introduced two key concepts that remain critical to computer hardware manufacturers to this day. First, because the Altair was mass-produced, the manufacturer was able (eventually) to obtain Intel Corp.s 8080 chips at an attractive price. Second, the Altair was based on an open-system architecture.

Furthermore, it was the Altair, gracing the cover of Popular Electronics, a magazine aimed at the electronics hobbyist, on January 1, 1975, that inspired Bill Gates and Paul Allen to develop a version of BASIC, the first language program for a PC. Following the Altair was a rash of introductions of other personal computing devices, including the Commodore PET, RadioShack Corp.s TRS-80, and the Apple II from Steve Wozniak and Steve Jobs. At that time, however, these PC devices were mainly the province of hobbyists.

In 1981, IBM introduced the IBM PC, launching the PC market and transforming the industry forever. The PC not only brought computers to a broader customer base, it also was one of the first IBM products to adopt an open architecture, in which IBM revealed the instructions and specifications. This enabled other companies to develop their own PC clones that would be compatible with IBMs machine, as well as peripheral devices, such as external storage, printers, and video and sound devices, among others.

This open architecture quickly evolved into a de facto industry standard. It included a microprocessor from Intel and the Windows operating system from Microsoft Corp. with its graphical user interface, which eliminated the need for users to remember the arcane commands required by its predecessor operating system, MS-DOS. Once computer makers were able to clone IBMs PC based on its open-standard architecture, PC sales took off, and prices came down. This effectively began the commoditization of the PC, which is still a major force in the economics of the industry.

The development of the PC coincided roughly with the birth of todays other major computing platforms: servers and workstations. Serverswhich, at the most basic functional level, closely resemble PCsare used by enterprises (corporations, governmental agencies, and educational institutions) to handle large computing needs. Servers have become so widespread that mainframes, while technologically distinct, are now categorized as another class of server. Together with the PC, servers created a new model of computing known as the client/server model, in which a client (normally a PC) requests a file or other information from a server via a network connecting the two. This allows the more powerful server to share its resources with many other, less powerful client computers.

Workstations are the other major computing platform. Introduced in 1982 by Sun Microsystems Inc. (which was acquired by Oracle in January 2010), they too are closely related to PCs. Essentially, they are high-end PCs with advanced graphics capabilities that are designed to handle data-intensive scientific and engineering applications.

COMPUTER FORM FACTORS

Just about every kind of computer comes in a variety of form factorsphysical designs that play a large role in determining the computers potential uses and markets. The most common form factor distinction in the PC market is that between desktop and laptop (or portable) computers. Laptops contain similar electronics to desktops, but they must also meet a unique set of requirements, such as reduced power usage and heat generation. Historically, a laptop or portable PC typically meant a notebook-sized computer, but in recent years, a smaller ultraportable form factoroften called a mini-notebook or netbookbegan to emerge as another type of laptop that allows users to connect to the Internet while on the go.


Tablet computers are a form factor somewhere between netbooks and laptops. In 2010, Apple scored a hit in the tablet category with the introduction of its iPad product. [Note that many market researchers, including IDC, count devices like the iPad as a media tablet, and not as a tablet PC, which has a more robust, PC-like operating system.] The high consumer appetite for tablets has essentially eliminated the netbook markets following the boom of 2009 and early 2010. In 2013, 221 million tablets were shipped, up from 144.2 million in 2012 and 76.2 million in 2011. Total shipments are expected to surpass 270 million in 2014.

Servers and workstations also come in a variety of form factors. In recent years, blade or rack-optimized servers, which are simply circuit boards designed to standard specifications, have become popular with corporations and other enterprises. They allow customers to create standardized, expandable computer racks and easily add or remove individual servers.

ASSEMBLERS, MARKETERS, AND MANUFACTURERS

The companies that produce PCs, servers, and workstations are often thought of as manufacturing companies; in reality, however, they do little more than assemble a standard set of components bought from various third parties. Since these components are often sourced from the same manufacturers, there is little real difference in the functional performance of most similarly equipped computers.

Computers are made from a relatively small list of components. At the heart of a computer is the motherboarda circuit board that holds the essential electronics of the computer. These include the microprocessor or central processing unit (CPU), memory chips, the program needed to start the computer, connections for add-on features like sound and video, and the circuitry known as the bus, which transmits information to and from the processor.

Most vendors of computer hardware buy motherboards already assembled. From there, they add a source of power, cables, disk drives, and a case to house them alleach usually sourced from outside as well. A keyboard, mouse, and display screen, also sourced externally, usually accompany the computer. The hard drive is the primary PC storage medium. IBM developed the first hard disk in 1956, but Seagate Technology LLC introduced the first hard disk for PCs in 1979.

Many of the most recognized computer hardware vendors, including Dell Inc., Apple Inc. (formerly Apple Computer Inc.), and Hewlett-Packard Co. (HP), assemble various components and market them to customers. Very few assemblers manufacture the microprocessors and other chips that actually make a computer work, and even these companies have begun to purchase motherboards and other components from third-party sources for their low-end PCs and servers.

Of course, relying on outside suppliers for crucial parts involves risk. Potential issues include defective parts, shortages, price increases, and reduced control over delivery schedules. Notably, Intel supplies about 85% to 90% of the microprocessors used in PCs, giving it enormous power over assemblers. Any or all of these factors can be significant to an assemblers profitability.

Computer assemblers and component manufacturers are often referred to as original equipment manufacturers (OEMs). While many assemblers are not true manufacturers, they are grouped as such in order to differentiate them as wholesale buyers that are distinct from the retail market for computer components.

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