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Shares of Brocade Communications Systems, Inc. (BRCD) have dropped 26.20% over the past 12 months, primarily owing to the negative sentiment following a fading takeover rumor and a patent lawsuit. Although the stock has managed to rebound by 5.08% since a month ago, at its current price of $4.76, I believe BRCD is still poised for a decent upside. My bullish view is based on the following three reasons:

1. BRCD remains undervalued. Analysts expect revenues, EBITDA, and EPS to rise by a 2-year CAGR of 3.2%, 14.8%, and 70.2%, respectively, over the current and the next fiscal years. That results in a reasonably valued PEG of 1.0x. But compared with its peers in the network equipment sector, the current stock price implies a substantial 29.8% valuation discount on both the peer average P/E and EV/EBITDA multiples (see below), which appears to be overblown given the company's solid fundamentals.

In terms of growth potential, BRCD is not overly worse that the group averages, as the faster EPS growth somewhat offsets the impact from its slower revenue and EBITDA growth. Profitability-wise, the company is just slightly off from the group averages in some measures, but has comparable gross and EBITDA margins. The robust FCF margin has helped the company maintain a fairly healthy balance sheet, as reflected by both current and quick ratios. As such, it would make a better sense for BRCD to trade at only a slight discount to its peers rather than at this sizable gap (see below).

Click to enlarge

2. Except for the period of economic downturn in 2009 and 2010, FCF has been improving over time (see below). The sizable FCF has more than enough to support the current size of share repurchase, suggesting there is a room for a potential increase in the buyback scale or an initiation of dividend down the road.

3. BRCD's CEO has purchased a total value of $489.5M shares in the firm at an average price of $4.45 - a bullish signal.

Bottom line: In the light of the attractive pricing, sustainable stock buybacks, and the confidence exhibited by insiders, I recommend acquiring BRCD at the current price or selling an out-of-money put option to wait for a more attractive valuation.

Table and chart created by author, and all financial data is sourced from Morningstar and Capital IQ.

Source: Why You Should Buy Brocade Communications Systems