Brocade Communications (BRCD) provides internet protocol based ethernet networking solutions and storage area networking solutions. It closed Monday at $4.69 and its long term chart looks like something seen only in Monument Valley. A majestic peak topping out at $126 in October 2000 and abruptly dropping down a sheer wall in early 2001 to level out below $15 a share for a decade never to rise again. It is a brutal reminder of how much money was lost on tech stocks - in this case, well after the March 2000 market top. This stock literally dropped like a paralyzed falcon and must have led multiple investors to swear to their spouses that they would never invest a dime in a tech stock again.
Anyhow, BRCD has been putting up solid numbers with steady, if unspectacular, growth. It has that attractive characteristic of many tech stocks - owner cash flow in excess of earnings. I have written about this phenomenon and it is due to several accounting factors. First of all, many tech stocks have depreciation and amortization that is larger than capex. Secondly, many tech stocks get paid in advance for upgrades and continued maintenance of a product and book some of the cash as deferred earnings. Finally, tech stocks tend to have a large amount of non-cash compensation - usually in the form of stock options - which must be expensed but does not require a cash outlay. This last item is a double edged sword because it means that, in order to maintain a constant share count, the company has to repurchase enough shares to balance the shares sold at a discount pursuant to stock options. The net result of these three factors is that tech stocks often have cash flow grossly in excess of income and can pile up mountains of balance sheet cash. Apple (AAPL) and Microsoft (MSFT) are probably the champions in this department.
I like to use the sequential balance sheet method to assess cash flow. In BRCD's case, the results of this analysis are impressive. In the six months ending April 28, 2012, BRCD paid down some $120 million of debt and piled up $130 million cash for a net balance sheet cash gain of $250 million or roughly 52 cents per fully diluted share. Strong earnings and depreciation and amortization in excess of capex were the main factors contributing to this gain but net sales of stock also played a role. To maintain constant share count, BRCD will have to repurchase some shares in coming months. But BRCD will also benefit from lower interest expenses as debt is paid down. Interest expense in the six month period was roughly 5 cents a share and that will disappear as debt is quickly paid off.
If we project BRCD's numbers over a full year we get cash flow of $1.04 per share growing to more than $1.10 a share when interest expense disappears. At $4.69, BRCD is thus trading for not much more than 4 times owner cash flow and qualifies as another cash cow tech stock. I have asked myself why some of these stocks are so cheap but, when I look at BRCD's historic chart, I think I am beginning to see the answer in that beautiful rock formation that shoots up out of the desert miles away. People really got brutally burned with this stock (and many, many other tech stocks) and vowed never, ever to return. It has a created a bargain for us value investors and I cannot be picky in sorting through the bargain basket these days. Needless to say, I am long BRCD.