A Flash in the iPod

Replacing iPod hard drives with flash memory could be good for Samsung, bad for Seagate.
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In a move that could have big implications for the storage and chip markets,

Apple

(AAPL) - Get Report

will unveil a new flash memory-based iPod later this year, say analysts.

The company will soon replace its hard drive-based 4GB iPod mini with a flash memory-based version that has the same storage capacity, Nam Hyung Kim, an analyst with industry research firm iSuppli, says in a recent report.

A report this week from Deutsche Bank Securities analyst Ben Lynch says Apple is expected to have the device on store shelves in time for the holidays; Kim says Apple is expected to ship 3 million to 6 million of the devices in the second half of this calendar year.

Should the reports pan out, the move could be a boon to the flash memory industry, particularly

Samsung

, which has struck a deal to provide Apple with flash memory chips.

Conversely, the deal could be a blow to hard-drive makers such as

Seagate Technology

(STX) - Get Report

and

Hitachi

(HIT)

, which have supplied hard drives for the current iteration of the iPod mini.

"With the iPod, Apple has already revolutionized the music industry. Now, because of the iPod's enormous success, Apple is reshaping the memory industry as well," said Kim in his report.

Representatives for Apple and Samsung declined to comment on the reports.

Seagate, based in Scotts Valley, Calif., has been widely reported to be among the hard-drive suppliers for Apple's iPod mini. Seagate spokesman Brian Ziel declined to confirm whether the company has a relationship with Apple.

However, Ziel says a wide market exists for the 1-inch drives that are used in digital players such as the iPod mini. "There's certainly a lot of talk about unpredictability in the 1-inch hard-drive space in the next six months. But we have a very broad participation in the market," Ziel says. "We are still very bullish on that market."

With its line of iPods, Apple has dominated the digital music player business, accounting for more than 73% of the units shipped in the U.S. in the first half of the year, according to the NPD Group, an industry research firm.

Though its initial players were all based on hard drives, the company jumped into the flash-based market earlier this year with its

introduction of the iPod shuffle.

Because flash memory itself is typically smaller and lighter than hard drives, flash-based players typically are smaller than their hard-drive-based rivals.

But flash-based players have had their drawbacks. While Apple's shuffle line immediately became the top-selling, flash-based music player, the product drew criticism for its lack of a screen.

In general, flash-based players have a fraction of the storage space available on hard-drive-based players. Apple's top-end shuffle, for instance, holds just 1GB of data, while its low-end, hard-drive player is the 4GB iPod mini.

A flash-based mini would seemingly address both of those criticisms -- offering the storage space available in a hard-drive based player and a screen to boot -- while allowing Apple to package it in a light-weight device.

Other analysts

recently predicted that Apple will likely introduce a slew of new products, including a new iPod, as soon as next month.

Market Moving

To produce the new 4GB flash-based iPod, Apple has contracted to buy as much as 40% of Samsung's output of NAND flash memory in the second half of this year, according to Kim. That's a potentially huge portion of global NAND output, the analyst said, as Samsung alone accounted for 55% of the sales of NAND memory in the second quarter.

NAND is one of two main flavors of flash memory, NOR being the other. NAND is typically used in digital music players because it's often less expensive than NOR, and it's able to write data more quickly.

Apple's NAND purchase will likely have ripple effects throughout the flash-chip and broader memory market, Kim said. Despite Apple's huge purchase -- or actually because of it -- average NAND prices are expected to decline in the near future, Kim said.

Samsung recently said that NAND flash prices would decline by double digits percentagewise in the second half of the year, Kim noted. But the decline in Samsung's prices and the broader market is likely attributable to the deal Apple has struck with Samsung.

Although NAND flash on average costs about twice as much as hard drives with similar storage capacities, Samsung has committed to matching the hard-drive price, Kim said. "Samsung has aggressively courted Apple's business, offering extremely low prices on its NAND parts in order to encourage Apple to convert the iPod line from

hard drives to its semiconductor memory.

"Samsung still will make money on this deal -- even at such low prices. For Samsung, sewing up the marquee iPod memory business is well worth the reduction in margins."

But even if the deal lowers prices, bargain hunters could still be left out. Instead, Apple's purchase will likely tie up much of the excess global NAND capacity, causing the spot market for NAND to jump in the second half of the year, Kim said.

"iSuppli advises ... companies to enter into more stable sourcing agreements with NAND makers. Otherwise they may face a risky supply situation that could negatively impact their business in the second half," he said.

Kim's comments were echoed in Lynch's report for Deutsche Bank.

"Apple's very successful flash-based ... iPod Shuffle changed the demand-supply dynamics of the NAND market earlier this year," Lynch said. "If Apple's new 4GB Flash-based

player becomes another big hit, we believe a tight NAND market is possible."

One further implication of Apple's move could be a spike in DRAM prices, Kim said. Apple is attempting to purchase more flash memory supply from South Korea's

Hynix Semiconductor

, he said.

If the company proves successful, Hynix will probably shift production from its DRAM memory products to flash memory, cutting into overall supply for DRAM, he said.

On the storage side, Apple's deal with Samsung raises questions for hard-drive makers Seagate and Hitachi, which

sell small hard drives for a variety of Apple's iPod music players and other products.

Sales of 1-inch drives, currently used in the iPod mini, are sure to take the biggest direct hit. But until Apple clarifies its plans, it's unknown how much Seagate and Hitachi will be affected.

"Our forecast still calls for a modest increase in 1-inch drives," says Dave Reinsel, a storage analyst with market researcher IDC. "But this news makes us want to instill more conservatism in our forecast."

Flash memory is significantly more expensive than hard drives on a per-gigabyte basis, but it's sturdier, more compact and uses less power. In an interview earlier this year, Pat O'Malley, Seagate's senior vice president, said he didn't think flash would be competitive with hard drives in players with a capacity of 4 gigabytes until 2007.

Hard drives for use in consumer-electronics devices account for roughly 10% to 15% of Seagate's revenue; how much of that revenue segment is tied to the 1-inch drives isn't clear.

However, Seagate's Ziel notes that the company has more than 30 customers for the 1-inch drives that are used in digital music players such as the iPod mini.

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None of the company's consumer-electronics customers -- which include manufacturers of digital video recorders and portable storage drives, as well as digital music players -- accounts for more than 3% of Seagate's overall revenue, he says.

The emergence of a market that includes digital music players, digital video recorders and even cell phones has given the storage industry, which has long been tied to the lagging PC business, a huge leg up.