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Rating Action:

MOODY'S PLACES MAXTOR'S AND QUANTUM'S RESPECTIVE DEBT OBLIGATIONS UNDER REVIEW FOR POSSIBLE UPGRADE

05 Oct 2000
MOODY'S PLACES MAXTOR'S AND QUANTUM'S RESPECTIVE DEBT OBLIGATIONS UNDER REVIEW FOR POSSIBLE UPGRADE

Approximately US$ 535 million Debt Securities Affected

New York, October 05, 2000 -- Moody's Investors Service placed under review for possible upgrade the B3 rating on Maxtor Corporation's outstanding $85 million 5-3/4% subordinated debentures, due 2012, the B2 rating on Quantum Corporation's outstanding $287.5 million 7% convertible subordinated notes, due 2004, and the (P)Ba3/(P)B2 rating on the remaining amount available from Quantum's $450 million shelf registration for senior unsecured and subordinated debt, respectively, from which the 7% convertible subordinated notes were issued. The review follows yesterday's announcement of Maxtor's proposed merger with Quantum's Hard Disk Drive group in an all-stock transaction valued at approximately $2.3 billion. Maxtor's B1 senior implied and senior unsecured issuer ratings have also been placed under review for possible upgrade. Additionally, Quantum's Ba3 senior implied and senior unsecured issuer ratings have been placed under review for possible upgrade as well.

The review will assess the potential for Maxtor, which would emerge as the ongoing company, to integrate two engineering driven organizations dedicated to quality production and technology excellence, while maintaining competitive pricing and volume flexibility. Whether or not the new combined entity is successful in retaining its pro forma market share of the desktop drive production, estimated to be about 40%, personal computer OEMs would have fewer vendors to rely upon for execution of leading edge product ramps. Their desire to continue the existing practice of second and third sourcing of drives from multiple suppliers could lead to some stabilization in average selling price declines, in contrast to the precipitous drops that have eroded profitability and forestalled recovery from the drive industry's protracted downturn, now entering its fourth year. Additionally, the review will take into account the likelihood of the combined company achieving projected cost savings in SG&A expenses of $120 million to $200 million that are anticipated to accrue within 18 to 24 months of completing the transaction, and the commensurate reduction from the implied cash flow improvement in pro forma debt leverage of 4.0 times based on EBITDA plus rentals over the LTM ended June 30, 2000 (July 2, 2000 for the Hard Disk Drive group). Upon closing, Maxtor would operate a substantially larger hard disk drive business, comparable in revenues to that of Seagate Technology's (Ba1 senior implied, under review for possible downgrade), and, within the desktop segment, the company's operations would be unparalleled in unit volume and breadth of customer base. Still, returns on assets and invested capital for this company, based on pro forma LTM EBITA plus rentals, have been nominal and would have to be improved dramatically.

The review will evaluate Maxtor's anticipated manufacturing model going forward which currently contemplates maintaining Quantum's partnership, established initially in 1984, with Japan's Matsushita-Kotobuki Electronics Industries, Ltd. ("MKE"), the contract electronics manufacturing division of Matsushita. Both Maxtor and Quantum acknowledge that MKE's three manufacturing plants provide the best high volume, low-cost manufacturing process within the industry which, along with the flexibility afforded by Maxtor's modular, work cell designed manufacturing facility in Singapore, would provide a dual production capability that could be highly responsive to short-term permutations in customer demand. The adoption over a projected twenty-four month time horizon of a set of common product platforms that could be assembled within each distinct manufacturing channel could be a major challenge for the combined company. Maxtor, which nearly collapsed after proliferating its drive platforms during the 1980s and early 1990s, simplified its production line to one that leveraged off a single basic platform with common components. It would now have at its disposal a broader complement of products and key market positions at Hewlett-Packard, Gateway and Apple, in addition to Dell and IBM. Additionally, Maxtor would be able to offer a product in the higher margin enterprise drive segment without the protracted trials required for first-time OEM qualification. Although Quantum's high-end enterprise drive program has performed unevenly in the past, never posing a serious challenge to Seagate nor IBM, the company has recently increased its market share and achieved an operating profit in its high-end unit in FY2001Q1.

Together, on a pro forma basis, the combined entity would present the strongest balance sheet in the business with over $1 billion in cash, and a debt to capitalization ratio, including Maxtor's off balance sheet funding of receivables under its asset securitization program and the capitalized value of both companies' operating leases, of significantly lower than 50%, even after factoring in the anticipated $100-180 million restructuring charges that would accompany the transaction. The company would additionally be able to avail itself of a portion, as yet to be determined, of Quantum's two revolving credit facilities, due 2001 and unrated, which were arranged in April, 2000 in the aggregate amount of $375 million and were undrawn as of July 2, 2000. In contrast to Seagate, which is being acquired in a leveraged buyout transaction, Maxtor would remain largely non-vertical in structure and would continue to rely on a collection of magnetic recording head, media and integrated circuit suppliers, several of which remain tenuously capitalized.

Additionally, the review will consider the dramatically contrasting corporate cultures of these two businesses. Maxtor, which virtually reinvented itself over the past four years, is a nimble, focused integrator of technology that has consistently executed in the intensely competitive desktop drive segment, commanding leading market shares at Dell and IBM. The company seized the lead from Quantum in time-to-market and time-to-volume manufacturing execution in late 1997 and has remained at the forefront in increased areal density per platter introductions since that time, although the intervals between initial qualification and volume shipment among the leading desktop drive purveyors have been narrowed to a matter of weeks. Quantum's Hard Disk Drive group, in Moody's estimation, is a more formally structured unit which has, through the collaborative effort with MKE, nearly matched Maxtor's timely execution but has failed to generate comparable gross margins. While the combination holds the promise of eliminating redundant R&D and budgeting resources toward identifying and developing more profitable storage opportunities, it could be difficult to forge a new corporate identity from such disparate operating environments.

Further, the fiercely competitive climate within the hard disk drive industry is not likely to attenuate. In the desktop segment, the company must contend with Seagate, infused with renewed vigor to rationalize its worldwide capital infrastructure and vindicate its vertically integrated business strategy. Upon being taken private, and unencumbered from the scrutiny of an uncompromising constituency of equity investors preoccupied by quarterly earnings attainment, Seagate may be able to accelerate its cost reduction efforts and become a more consistent rival for time-to-market and volume manufacturing dominance in the desktop. At the same time, a leaner and revitalized Western Digital Corporation (B2 senior implied, negative outlook), which, in the wake of this merger, stands to command even more attention than it's recently garnered from the OEMs, could yet recover from the transitional difficulties that have left the company languishing in a sea of red ink after its delayed implementation of magnetoresistive (MR) head technology. Western Digital has managed to sustain a reasonably liquid balance sheet while incurring substantial net income losses over its past three fiscal years through the divestiture of its capital intensive media operation, the periodic issuance of modest increments of common equity, the negotiated conversion of a substantial portion of its outstanding zero coupon convertibles, and the arrangement of a new revolving credit facility. Although Maxtor intends to maintain the continuity in its components supplier base, changing industry dynamics may lead the company to reassess its rejection of a vertical integration strategy. The company's impending reliance on a dependable supply chain for substantially larger unit volumes and the demands from a more elaborate product line on new technology introductions could force the company to align itself with fewer components suppliers and contribute more heavily, either directly or indirectly, to their capital expenditure requirements.

The review of the ratings on Quantum's continuing debt obligations will evaluate the company's business going forward, which would consist exclusively of its existing DLT & Storage Systems group business unit, a $1.38 billion enterprise with stellar returns on assets and invested capital, based on EBITA plus rents, of 38.6% and 48.2%, respectively, over the LTM ended July 2, 2000. The DLT (digital linear tape) & Storage Systems group designs, develops, manufactures, licenses and markets DLTtape™ drives, DLTtape media cartridges and storage systems. DLTtape drives accounted for 30% of total tape drive market revenue in 1999 from a roster of companies that included Compaq, Dell, Hewlett-Packard, IBM, Storagetek and Sun Microsystems. Outstanding debt remaining with the DLT & Storage Systems group would comprise a mere .7 times LTM cash flow. As of July 2, 2000, the DLT & Storage Systems group's capitalization was comprised of a reasonable 62.5% equity and 37.5% debt, including the capitalization of the company's operating leases. The unit's gross margin's have consistently exceeded 40%, substantially higher than Quantum's Hard Disk Drive group which achieved about a 14% gross margin in FY2001Q1 after failing to top 9% in each of the past three fiscal years. The review will consider the growth prospects for tape storage back-up, the competitive environment for tape cartridges and tape libraries, and the R&D and capital expenditure funding requirements entailed in maintaining the company's leading business position.

Maxtor Corporation, a leading supplier of information storage solutions, including the manufacture of hard disk drives for the personal computer market, has its principal executive offices in Milpitas, California.

Quantum Corporation, also headquartered in Milpitas, California, is a diversified data storage company which, through its Hard Disk Drive group, is a leader in the development and marketing of a diversified portfolio of hard disk drives, and, through its DLT & Storage Systems group, is the worldwide revenue leader for tape drives used for data storage and back-up.

New York
Pamela Stumpp
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653

New York
Howard Sitzer
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653

No Related Data.
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