Expect a Selloff for Brocade

Whatever your feeling on the overall market direction, some stocks have rallied off their March lows much too aggressively. Furthermore if you expect some further hiccups, these stocks should fare much worse than the overall market due to their volatility and long term resistance that is now in sight. In short, these are the types of stocks you want to sell.

A prime example is BRCD, or Brocade Communications Systems Inc.

From a technical perspective, this stock is an interesting short. As we can see from this chart, BRCD has been range bound since it crashed back to earth after the tech bubble burst. Currently it is near the high end of it range and should be bumping into almost a decade’s worth of very strong resistance. Literally for over a decade, anyone who has bought above these levels is at a loss. Furthermore, it just stands to common sense; if BRCD could not hold these levels in 2006 and 2007, when the business cycle was peaking, it should not be able to sustain these prices now. Even if you believe the economy is improving worldwide, the consensus calls for a period of slow growth for quite some time, another negative for BRCD’s stock price considering its prices are implying a very strong recovery.

BRCD seems to just be way ahead of itself. Considering how the valuation of BRCD is implying something much different than what is likely to happen in the broader economy, and very stiff resistance overhead, BRCD should have a very difficult time moving any higher. Shorting the stock now, with a stop just above its most recent highs, and using a zone of support in the 5 dollar region, you have a trade with a risk reward of about 3 to 1. If you believe the market is heading for a correction, this stock could be cut in half.

Disclosure: Currently no position in BRCD.

Comments

[InvestBaboo:]

You are comparing apples with oranges.

Brocade is a very different company now. They have acquired Foundry which gave them a whole new range of products. Also, from the Brocade side of the house have come a whole new range of products that have taken market share away from Cisco. Their OEM strategy is new and is getting them major vendor one after another.

If you had applied this logic to Apple which was range bound for a long time then it would have never traded at current levels. Your logic makes no sense.

Aug 17 06:02 PM

[Bill L.:]

Maybe on the corporate side they can execute a new strategy better, but historically acquisition and integration is difficult to pull off. I'm sure the current environment isn't helping. But regardless, in terms of the stock, it's approaching an area where I believe many investors will be questioning how much upside is left. Couple that with the stock high statistical volatility, and a market that looks like it may be on the verge or correcting... In the long term you may be right, but the stock looks like it faces a serious pullback in the interim.


On Aug 17 06:02 PM InvestBaboo wrote:

> You are comparing apples with oranges.
>
> Brocade is a very different company now.

Aug 17 06:16 PM

[InvestBaboo:]

What you have not taken into account in the short term is the power of leverage made available to Brocade with the multitude of OEM deals. None of these are cross channel (no channel conflict) -- they are all additive. This is the reason (as it is rumored) that Brocade has kept suitors at bay and seeks future as an independent entity where it believes it can deliver far higher value to shareholders.

Expect Brocade to significantly revise upward its future forecast which will cause a runup in the stock and break of the resistance at 9 and change. From thereon it is uncharted waters as the stock will seek new levels without historical baggage. Earnings coming this Thursday.

Aug 17 06:26 PM

[Bill L.:]

Can you send me a link on this?


On Aug 17 06:26 PM InvestBaboo wrote:

> What you have not taken into account in the short term is the power
> of leverage made available to Brocade with the multitude of OEM deals.
> None of these are cross channel (no channel conflict) -- they are
> all additive.

Aug 17 06:54 PM

[InvestBaboo:]

You are kidding me. Brocade's signing of OEM deals over the past several weeks is in the public domain. Why, just this week it signed a deal with NetApp. A deal with Dell is reportedly in the works but rumor has it that Dell wants more than just an OEM deal. An OEM deal with HP has been in the works for a long time but not announced yet (we will have to find out why during the conf call). One of the best sources for checking rumors is TheFlyOnTheWall.


On Aug 17 06:54 PM Bill L. wrote:

> Can you send me a link on this?

Aug 17 07:01 PM

[pocono:]

BRCD HAS THEIR HANDS IN EVERYTHING! AND MORE AND MORE COMPANIES R USING THEIR SERVICES. THAT TO ME IMPLIES GROWTH NO MATTER WHICH WAY U LOOK AT IT. IT WILL ONLY GET CUT IN HALF IF PEOPLE BELIEVE THESE SUPID RUMORS, IN WHICH CASE, ID TRIPLE MY POSITION

Aug 17 09:23 PM

[Bill L.:]

What growth rate are you applying? With a simple dcf it looks like they need a growth rate of over 10% (consistently) to justify it's current price. If you think that's doable, more power to you. I hope your long works out. But looking at their spotty EPS record... all I'm saying is here's were some may start to bet against the stock.

I have no position in the stock, so how about a, "thank you for a different point of view, but you didn't consider....", like baboo.


On Aug 17 09:23 PM pocono wrote:

THAT TO ME IMPLIES GROWTH NO MATTER WHICH
> WAY U LOOK AT IT.

Aug 18 10:35 AM

[Wisdom vs. ...:]

this sector is consolidating, and everyone has orders but no deliveries; those of you who get excited about either are deluding yourselves. the cloud is extremely disruptive, less equipment will move more bits-- far more. everyone has 10G equipment that works now so it is commoditized, and several companies are skipping 40G and developing 100G-- who will survive THAT shift? also, enterprise just laid off 6M employees, many will not need to expand networks for years. companies like BRCD that have high PEx are unlikely to increase in price any time soon

Aug 18 12:47 PM

[Bill L.:]

That's an interesting story, but again, it's a story, and stories usually surface after a stock is say, up 300% off the bottom. Again, their earnings have been spotty and have been in and out of the red for several years now. Maybe you're right that they will turn their business model around, but the time to bet so was 6 months ago when the risk reward was much more attractive. Fundamentally they need to grow aggressively in a depression to make the price justified and technically this is historically where buying has stopped. All I'm offering is a second opinion, so good luck, and good trading.


On Aug 17 06:26 PM InvestBaboo wrote:

> What you have not taken into account in the short term is the power
> of leverage made available to Brocade with the multitude of OEM deals.

Aug 18 01:37 PM

[Wisdom vs. ...:]

i meant 2G, 4G and 8G on my comment above, sorry, had optical on the brain

Aug 18 10:46 PM

[Cormack:]

Great article, Bill. Even though there may be quarterly sequential accelerations in gross margins, BRCD has horrendous net profit margins according to the data provided by Yahoo Finance and their revenues came in below consensus estimates where the consensus was expecting more than half a billion in revenue for the quarter. Shares down over 5% afterhours.

Aug 20 06:45 PM

[Bill L.:]

Thanks Cormack, honestly I was surprised at all the negative feedback. If you were a bull on this stock, I felt that basically your dreams had come true as this stock reached a historically very fair price to sell the stock.

Pocono, I feel you will soon get your wish of a price where you can triple your position.

Aug 21 03:47 PM

[Cormack:]

The problem with stories as you pointed out is that they are all about generalities and future pipeline potential from OEM deals when the more important factor pertains to quarterly sequential and year over year comps in the net operating margin as well as gross margins. Sequential declines in any of those areas are bad in any short run environment. Then they deliver revenues that are below consensus estimates which exacerbates a negative reaction and the fundamentals on top line and bottom line EPS.

Aug 27 01:40 AM

[Bill L.:]

Brocade appears to be finding support here, and has been able to fight off the drag of a negative market. Taking a wait and see approach but I'll be watching more carefully. Ultimately I expect BRCD to roll over with the market. But one day at a time.

Sep 02 07:41 PM

[looking_fro...:]

Baboo, Bill obveously was correct about the sell off in Brcd. If it was me I would write here and state that you were completely incorrect but since you are not man enough, you simply left the site.
Most likely even changed the name :) Good bye and good luck!
Bill You were correct, excellent article. Thanks, you were right 100%


On Aug 17 06:02 PM InvestBaboo wrote:

> You are comparing apples with oranges.
>
> Brocade is a very different company now. They have acquired Foundry
> which gave them a whole new range of products. Also, from the Brocade
> side of the house have come a whole new range of products that have
> taken market share away from Cisco. Their OEM strategy is new and
> is getting them major vendor one after another.
>
> If you had applied this logic to Apple which was range bound for
> a long time then it would have never traded at current levels. Your
> logic makes no sense.

Sep 03 06:58 PM

[Archer181:]

If you are betting man and wanted to double up from this point on.
Which one of these famus co. you pick;
CSCO
JNPR
IBM
HPG
DELL
BRCD

Sep 03 07:27 PM

[Bill L.:]

Are you asking me? Well to be honest, I wouldn't be buying anything at this point in time. This is a time to lighten up or even go short if you are aggressive. You don't have to always be in the market.

www.cleanmpg.com/photo...

This picture is the ONLY fundamental data that people should be focusing on. As long as debt is high enough to affect real GDP, we are in for deflation I'm sorry to say.

Sep 13 12:21 PM

[looking_fro...:]

Bill again. You are right on the money with the article about brcd and the dollar. I hope you will make money on your spy puts!
Congratulations and I will be following you from here on.

Sep 22 06:08 PM