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Lanette Donovan is General Partner and Portfolio Manager of Beresford Capital. Ms. Donovan has seventeen years of equity research and asset management experience. She has worked as a senior equity research analyst and portfolio manager with MacKay Shields, LLC; Deutsche Bank Asset Management;... More
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  • Does Dell buy Brocade? 0 comments
    Jun 6, 2011 12:57 PM

    Brocade (NASDAQ:BRCD) stock rose sharply on Friday on rumor that Dell will buy the company to acquire networking technology.  This was partly fueled by Michael Dell speaking at an investor conference and not denying that Dell has interests in acquiring networking technology and businesses to help them focus on the small and medium and large/med business market.  Also the analyst covering BRCD at Canacord suggested that it would be a great idea.

     

    So what is BRCD worth and does Dell buy them?  First let’s look at the numbers.

     

    Currently BRCD stock at $7.25 is trading with a mkt cap of $3.632 billion. The company has debt of $890 million and cash of $416 million.  This equates to an Enterprise value of $ 4.1 billion. 

     

    BRCD is estimated to have FY 2011 Sales of $2.222 billion of which 59% is from Storage products or $1.3 billion and 25% from Ethernet Switching or $547 million, and 17% from services related to products. 

     

    Company EV to Sales right now is 1.85x – looks cheap right?  But lets look at the business by segment.

     

    The storage segment which is 59% of sales is fiber channel SAN switching.  This market segment is longer term in decline as the world moves to converged (IP- Ethernet and FC over Ethernet) networks in the data center.  BRCD does expect one more upgrade cycle in FC switching starting this year to 16 GB FC technology but even with this expectations for the storage business is expected to be mid single digit revenue growth.  As the transition occurs to Ethernet (10G) there are many more competitors – 9 by current count- versus 3 in FC today.  Pricing should be extremely competitive.

     

    So what would one pay for a declining market product business?  Less than 1 times sales has been a proxy in tech.  (HP is trading at .60 x EV to Sales).   Given the transition risk and the ultimate TAM of a converged switch market (less then current FC market)   .5- .6 X sales seems fair.

     

    The Ethernet switch business is the reason Dell would care.  BRCD is in front of a new product cycle.  The company touts it is first to market with a next-gen data center fabric switch– called VDX.  It has shipped to 100 customers that have the switch in test environments and 2012 should see accelerating sales adoption.  However, the current sales in BRCD IP segment are predominantly campus Ethernet switches which is currently a highly competitive price sensitive market dominated by Cisco.  But for argument sake let us say this business deserves a price –to-sales multiple paid for high flying but yet proven next-gen tech companies and or a networking company.   We do have a couple of compares.

     

    Dell paid $820 million net or 5.3 x estimated 2010 sales for Compellent last year.

    HP paid $2.7 billion net or 2.1 x sales for 3COM.

     

     

    LETS COMPUTE

     

    Storage:  .55 x $1.3            =  $ 715

    Ethernet   5.3 x .547            = $ 2900

    Services 1 x 369            =  $ 369

     TOTAL PRICE              $3,986 billion or $7.95per share.

     

     

    BUT THE REAL QUESTION TO ANSWER IS DOES DELL OR ANY OTHER COMPANY NEED TO BUY BRCD TO GET NEXT GEN SWITCHING TECHNOLOGY?  WHY PAY FOR SAN FC SWITCHING TO GET 10G FABRIC ETHERNET SWITCHING WHEN THERE ARE MANY PRIVATE COMPANIES WORKING ON THE SAME COLAPSED ARCHITECTURE.

     

    Arista Networks and Force10 are two private companies with solid technology that come to mind.

     

    Does Dell need BRCD’s sales force? No, Dell resells BRCD and BRCD needs them more then Dell needs BRCD.

     

    Hence, I would be disappointed if Dell actually bought BRCD.  I don’t think they will nor do they need to.  There are better technology and product acquisitions candidates around.   Unfortunately for stock market investors they are private companies.

     

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