Dissecting the Brocade-Foundry Merger

By Chris Preimesberger  |  Posted 2008-07-22

Dissecting the Brocade-Foundry Merger

Brocade Communications' $3 billion acquisition of neighboring Foundry Networks, announced July 21, is all about connectivity, and it is causing plenty of talk in the storage and networking analyst communities.

After all, if this deal closes as expected this fall, Brocade will have pulled off one of the largest networking sector acquisitions in IT history.

The acquisition now will allow Brocade salespeople to pitch one converged network featuring Fibre Channel SANs (storage area networks), IP 10 Gigabit Ethernet, or both, to potential customers. Simple is always better when it comes to explaining complicated IT networks and trying to sell them.

The deal also makes Brocade-which will become a $5 billion (market capitalization) company after the merger-a much more formidable foe for networking infrastructure kingpin Cisco Systems ($129 billion market capitalization), which has owned the lion's share of the Internet switching and routing market since the dawn of the commercial Internet and the Web in the mid-'90s. 

Until now, Brocade has offered primarily top-of-the-line Fibre Channel connectivity for SANs. With the addition of Foundry, the company will offer a complete lineup of networking infrastructure that will include much-needed security improvements.

Many enterprises need to bolster their infrastructures to support the growing preponderance of Web-based and mobile applications, and this merger will provide a realistic new alternative for CTOs and CIOs to consider. As recent failures of high-profile Web-based infrastructures have shown-namely, outages at Amazon S3, Salesforce.com, Google and others-the importance of robust, up-to-date systems that can handle high volumes of transactions cannot be overvalued.

Deal means instant credibility

"This gives them [Brocade] instant credibility to say, 'We now know Ethernet. We brought this company on that's 12 years old, has however many millions of ports deployed, and has a good product,'" Bob Laliberte, storage/networking analyst at Enterprise Strategy Group, told me.

"They're also going to be able to say, for the first time: 'Hey, we are completely transport-agnostic. We're going to help you with your data center fabric, whether that fabric is Fibre Channel, Fibre Channel over Ethernet, iSCSI, or pure Ethernet.' "

The 451 Group, an IT research group, issued what it called an "M&A QuickTake" analysis of the deal and its likely effects on the IT market and on both companies. It was authored by the triumvirate of analysts Henry Baltazar (a former eWEEK Labs staff member), Brenon Daly and Steve Steinke.

The report said, in part:

"Brocade went out of its way ... to contrast this acquisition, which it says is focused on revenue growth, with the consolidation of McData, which was more about cost savings. Since that deal in August 2006, Brocade shares have tacked on about 35 percent in value, nearly three times the return of the Nasdaq market during the same period."

However, Wall Street's initial reaction to Brocade's new acquisition was bearish. Investors weren't overly excited about the transaction, trimming about 15 percent off Brocade's closing price in after-hours trading July 21.

The stock closed at $6.50 on July 22, down another $1.83 (about 22 percent) from the previous session. Foundry's stock price, on the other hand, was up 32 percent at about $18 per share on July 22.

Why the negative attitude toward Brocade here?
"When we look at this combination, we're tempted to call it a 'mini-Cisco,' as the newly expanded product portfolio at Brocade looks a lot like what the networking giant has been pitching," the 451 Group report said.

The Brocade-Foundry marriage faces a number of severe challenges, including how the combined company sells its gear and who actually buys it. The report continues:

"Brocade has always relied to a great extent on its OEM partners, with IBM, Hewlett-Packard, and EMC accounting for some two-thirds of the company's total revenue. On the other side, Foundry primarily takes in revenue through direct sales and its network of resellers. (We would also note Brocade could face difficulties in preserving its partnership with HP, given that Foundry's networking lineup competes fiercely with HP's ProCurve switches.)

"Another potential snag is the fact that Brocade and Foundry sell to very different end users within the enterprise. Brocade typically sells to storage and server IT staff, while Foundry caters more to network managers. In order to push a converged product, the combined Brocade-Foundry will have to navigate inter-office political boundaries to get approvals, a process that could prove difficult."


More than meets the eye


So, there's more to this deal than what shows on the surface. It is not a slam dunk by any means, even though both Foundry and Brocade CEOs spoke in superlatives on the conference call with analysts and journalists. Of course, no merger in any market is expected to be as smooth as glass; there are always obstacles-expected and unexpected-to clear.

"Brocade now is competing directly with Cisco in the data center, whereas they owned the storage networking sector in the past," Laliberte said.  "If you're Cisco, you're going to take notice of this [new competitor], because in the past, Cisco would go into a new prospect and say, 'Hey, we know IP, we own this market, we invented it. You need to go with us.'

"Now they can't really say that.  They can still say, 'We're the biggest, we're the baddest,' but now Brocade has a legitimate stake to put in the ground and say, 'We know Ethernet, too. We've been doing it for 12 years.'

"By combining the best of Fibre Channel and the best of what they can take from Foundry's expertise, Brocade can deliver a compelling solution as well."

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