| ||||||||||
| ||||||||||
— Analysis —
But right now, shareholders aren't cheering about the company's vision, as forward-looking as it might be. San Jose, Calif.-based Brocade announced the transaction, the priciest in its 13-year history, after the market closed on July 21; the following day, its shares plummeted 22%. In a market like this, it's not easy for an acquirer to convince investors of the long-term prospects of a large acquisition, especially if a company is, by most accounts, doing relatively well on its own.
"Investors were surprised," says Brent Bracelin, an analyst with Pacific Crest Securities Inc. "Brocade is in the midst of a new product cycle, and investors were excited about the prospects of the company's accelerating growth -- alone." The potential for distraction stemming from a major integration, coupled with the Silicon Valley technology company having added $1.66 billion in debt to finance part of the deal, upset shareholders. But Brocade CEO Michael Klayko hopes for patience, because if the enterprise data center looks anything like he and some experts expect it to in several years, those that hold on to its shares could be rewarded handsomely. Today the various systems in a data center -- the climate-controlled nerve center of a modern, large enterprise, where telecommunications, internal networking, computing and storage systems are housed -- communicate over a hodgepodge of networking technologies and protocols. Computer networks are connected with Ethernet technology, a long-standing, widely used way to link the various parts of local area networks, or LANs. Selling Ethernet switches and other equipment to big companies and service providers has been Santa Clara, Calif.-based Foundry's specialty. Server connectivity is based on InfiniBand, a high-speed communications link technology primarily used in high-performance computing. Storage area networks, or SANs, use so-called fiber channel technology -- Brocade's forte -- to communicate. Most observers think these connectivity methods will eventually -- in three, four, maybe five years -- merge into one. These interconnect technologies are extremely complicated to design and perfect, so the coming convergence will take time, says Yankee Group Research Inc. analyst Zeus Kerravala. Juniper Networks Inc., for example, took about four years to develop its own Ethernet switch, "even though they knew what they were doing," he says. Exactly how the so-called converged network will look is a guessing game, but most agree that for any company to have a shot at winning, it must have all the necessary technologies, such as Ethernet and fiber channel, in its quiver. Not surprisingly, top networking company Cisco Systems Inc. has been working toward this goal by striking various acquisitions for some time, and earlier this year it shook up the data center world by launching its Nexus data center switching platform. The move is widely viewed as bringing San Jose, Calif.-based Cisco a step closer to providing a converged enterprise network because it combines Ethernet switching with storage networking technologies and has the capability to integrate new technologies, too. Just as Cisco and now Brocade are gearing for the future of the unified data center, other networking rivals risk being left behind, Kerravala says. "Other network vendors like Juniper and Nortel and Alcatel have put their hands over their ears like little kids and ignored this," he says. "If no one steps up, then Cisco will just walk away with it. So it's good to see that Brocade recognized something had to be done." Brocade, like so many other major networking technology companies, tends to avoid mentioning Cisco by name. T.J. Grewal, (pictured) the company's vice president of corporate development, says the Foundry deal is about offering customers an alternative with the scale of a broad, global footprint. Kind of like, well, Cisco. "Based on the research we've done in due diligence, we know that customers are asking for more choice in terms of a credible, trusted option in end-to-end networking solutions," he says. "With this deal, we are now that option." In explaining the big premium Brocade paid -- when the deal was announced, the offer valued Foundry at $19.25, a 40% premium to its previous closing price -- Grewal and the company's outside advisers at Banc of America Securities LLC came to realize the combination would create a big growth opportunity. One must be willing to pay up for that, Grewal says. "We see lots of acceleration opportunity here, and once that gets locked in and you see the light, then you are willing to think of the math that gets the transaction done," he says. Grewal also argues that the meaty premium paid for Foundry must be viewed in the context of the depressed stock valuations among many midtier networking companies. "You have to understand the sentiment in every boardroom and management team -- they all feel they are being unfairly valued in the public market," he says. "It's even more so for smaller-cap companies, who have seen the whipsaw effect of the market." It would be hard to argue that Brocade is buying damaged goods. The same day the deal was announced, Foundry reported second-quarter results that topped Wall Street expectations. It announced 12% year-over-year revenue growth and net income of $18.3 million, an increase of 17% over the year-earlier period. So it's no surprise Brocade has repeatedly said the Foundry deal is not about cost cutting, although it is expected to trim costs by $30 million to $33 million by fiscal 2010 by redesigning each companies' products to lower production costs. General and administrative costs will drop by $10 million to $12 million by 2010, the company predicts. Grewal says this helps set Foundry, which began in 1996, apart from McData Corp., a storage networking equipment provider Brocade acquired for $713 million in early 2007. Brocade had to wrestle to clear the deal with the Federal Trade Commission because of the concentration it ostensibly would create in a portion of the market in which both companies operated. The integration, still ongoing, was challenging as well, more so than is expected with melding Foundry, Grewal says. "These are two very different deals," Grewal says. "McData was about cost synergies, with lots of overlaps. None of their execs came over to Brocade; you won't see the same situation with Foundry." That's the plan, anyway. But, as with all big technology deals, the target's most valuable assets walk out the door at the end of each day, and some view the risk of them not coming back as particularly marked in the Foundry transaction. One problem, Kerravala says, is that it's unclear whether Bobby Johnson Jr., Foundry's founder and CEO, will stay on after the deal closes. During the conference call to discuss the transaction, Johnson told analysts his role in the merged company is "still undefined." "Foundry is small, and its had the same management team in place for years," Kerravala says. "If Bobby ends up being the odd man out, there's a big risk that all his loyal generals will leave with him." As with almost all technology acquisitions, the Brocade-Foundry marriage faces a major challenge. But if Brocade can keep the Foundry brain trust mostly intact, it will be one step closer to making its vision of the unified data center a reality. |
By spending 
|
|
|
|
|
