Analysts: Synergies Are Good for Brocade-McData Union

By Chris Preimesberger  |  Posted 2006-08-08

Analysts: Synergies Are Good for Brocade-McData Union

Analysts say that the synergies between data storage equipment maker Brocade Communications Systems and rival McData—which Brocade said Aug. 8 it will acquire for $713 million in stock—are good and that the proposed merger should eventually bode well for both companies.

Brocade executives told investors and analysts in a hastily arranged early-morning conference call that it will acquire rival McData for $4.61 per share. The purchase price equaled a 48 percent premium above Mondays $3.11 closing price on McDatas Class A shares.

If the deal is completed, Brocade, based in San Jose, Calif., will have increased its net worth from $1.55 billion to just under $2 billion, according to Standard & Poors CapitalIQ.

McDatas enterprise value was listed at $455 million at the time of the transaction, CapitalIQ said.

When the deal is competed, McData stockholders will own about 30 percent of Brocade, a Brocade spokesman told eWEEK. McData, in Broomfield, Colo., will become a wholly owned subsidiary of Brocade, and John Kelley, McDatas chairman and chief executive, will serve as an advisor to Brocade after closing.

Both companies boards have unanimously approved the merger. It still requires regulatory approval and a positive vote from Brocade and McData shareholders.

Brocade and McData each provide storage networking and data infrastructure hardware, software and services worldwide. They compete in the enterprise storage networking and OEM markets against such formidable foes as Cisco Systems, QLogic, and Emulex.

Next Page: Wall Street nonplussed.

Wall Street Nonplussed

Wall Street nonplussed

Wall Street investors apparently werent thrilled with Brocade after hearing the news. Brocades stock price had dropped 19 percent by late afternoon Aug. 8 to $4.98 per share from Aug. 7s close of $6.14.

However, Tony Asaro, senior analyst with the Enterprise Strategy Group in Milford, Mass., was a bit more bullish on the transactions potential.

"This was actually a smart move," Asaro told eWEEK via e-mail. "They both needed to do something major to get them to the next level."

Asaro said he sees good synergies in the deal.

"McData typically does better at the high end in enterprise with its Director-class switches, and Brocade with lower end and midsize systems," Asaro said. "They have a much more complete portfolio now."

It all comes down to execution, Asaro said.

"Big mergers are always a challenge—and they will eventually have to streamline and consolidate. If they can move forward without politics and in-fighting and use this to build momentum then it could be a major step forward," he said.

Brian Babineau, the Palo Alto, Calif.-based storage analyst with Enterprise Strategy Group, agreed that "there are plenty of synergies, as these two companies are competitors; the goal for Brocade is to achieve cost-cutting initiatives without impacts on McDatas customers.

"Also, Brocade has recently augmented its portfolio to include information management software, a reasonable diversification from the hardware plumbing known as fibre channel," Babineau told eWEEK.

"Brocade needs to balance reinvesting the cost savings to its emerging business and dropping it to the bottom line. Wall Street will be appeased if Brocade cuts costs fast and returns a reasonable portion of these savings to investors."

Mark Kelleher, an analyst with Canaccord Adams in Vancouver, B.C., said he didnt think synergies were a problem but said that McData has had a "difficult" market position for a long while.

Even though consolidation seems to be a trend in the industry, he said, he questioned the timing and the premium Brocade is paying.

Click here to read more about Brocade and McDatas switch upgrades.

"McData has almost complete product and customer overlap, and was losing market share fairly rapidly to Brocade," Kelleher told MarketWatch.

"Given another six months, the assets of McData likely could have been consolidated for significantly less cost to Brocade."

Tom Buiocchini, Brocade vice president of marketing, told eWEEK that the bottom line is that "the acquisition will provide better offerings for our OEMs and our customers.

"Weve had four record quarters in a row," Buiocchini said. "Our customers keep telling us: Go faster! Go farther! This transaction gives us a lot more fuel in the tank for us going forward. McData has a broad product line and a great service organization, and we think its a win-win situation all around, because well be able to go to market faster with better products."

Next Page: Big cost savings expected.

Big Cost Savings Expected

Big cost savings expected

A Brocade spokesperson said the purchase, which is expected to close next quarter, would help it gain scale and accelerate growth, leading to yearly cost savings of $100 million by the fourth quarter.

Brocade has forecast third-quarter net revenue of $188 million to $189 million and net earnings per share of 8 cents to 9 cents.

McData reported that it expects Q2 earnings per share to range from a loss of 2 cents per share to break even on revenue of $150 million to $152 million—far below the companys previous estimate of $170 million to $180 million.

In its most recent financials, McData blamed weak sales in North America as well as at its unit that handles Europe and the Middle East. It also cited lower demand for some of its top-of-the-line products.

Brocade has been in the news recently due to an ongoing SEC investigation involving fraud charges.

The SEC last month filed civil fraud charges against the former CEO, Gregory Reyes, and two other officials of the company.

Reyes and his colleagues face criminal fraud charges that carry a maximum penalty of 20 years in prison and $5 million in fines. Reyes attorney, Richard Marmaro, has said his client is innocent.

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