Brocade's Corporate Development Chief: Networking Co. Can Compete with Anyone

Includes: BRCD, CSCO, FDRY
by: The Deal Economy

Shortly after T.J. Grewal took the role of vice president of corporate development at Brocade Communications Systems Inc. (NASDAQ:BRCD) in August 2004, the storage technology company struck what was at that time its biggest acquisition -- the $713 million acquisition of smaller rival McData Corp. It was trial by fire for the 41-year-old Grewal, a former tech consultant with McKinsey & Co. The U.S. Federal Trade Commission raised antitrust concerns and integration was challenging.

Grewal's latest project is the $3 billion agreement to acquire networking equipment maker Foundry Networks Inc. (FDRY), announced July 21. As with McData, he was instrumental in hammering out the Foundry agreement and will lead the integration.

Grewal says that absorbing Foundry will go more smoothly. The companies make different kinds of networking equipment. Foundry will operate as a separate business unit, and Brocade plans to retain most of the acquired company's executive team, which wasn't the case with McData.

That said, news of the Foundry deal was not greeted with applause from investors. The price tag amounted to a 40% premium on Foundry's pre-announcement share price, and shareholders reacted by dumping Brocade stock. Beyond the usual fears that such a big deal could prove distracting, investors were concerned about the rich price and that Brocade is taking on $1.6 billion in debt to finance the transaction.

Grewal says it might take some time for Wall Street to process the long-term benefits of the deal for Brocade. Chief among these is that the merged company can offer end-to-end networking equipment for connecting storage systems, server banks, and high-powered computer and telecommunications and Internet systems. It'll take a few years for this vision to become reality, he says, but Brocade wants to be prepared when it does, lest the biggest player in networking -- Cisco Systems Inc. (NASDAQ:CSCO) -- walk away with the prize unchallenged. 

Grewal recently spoke with Tech Confidential about the Foundry deal.

Tech Confidential: When did the idea for this deal come about?

Grewal: From a strategy standpoint, we looked at how different points of intersection would happen, three years back. We decided to build a converged Ethernet product. The effort was put into how to accelerate into this market; that began almost a year ago. It wasn't a case where two CEOs happened to call each other three weeks before a deal was announced. We looked at the different scenarios: invest in own business or look for an asset that could accelerate our entry into this space. It was a drawn out, in-depth process. You can imagine all the different things we looked at.

Some have said there were no other bidders for Foundry. If that's the case, what should investors take away from the big premium you paid?

I won't talk about bidders. The thing to keep in context is that you're seeing a flat to down market. You have to understand the sentiment in every board room and management team. Everyone feels they're being unfairly valued in the public market, and it's even more so for smaller cap companies.

We did lots of deep diligence here, directly into the company and directly into the market to understand buyers. We see lots of acceleration opportunity here. Once that gets locked in and you see the light, then you're willing to think of the math that gets the transaction done. It still needs to be financially sound, and that was clearly something that we focused on.

We are putting our balance sheet to work effectively with out overburdening it. Both businesses are good at generating cash. And there's a real opportunity for growth.

What did you learn from the experience integrating McData that you can apply to the Brocade deal?

McData was about maintaining a customer base from a market perspective; they were falling behind on product cycles. It was about cost synergies--there were lots of overlaps.

The Foundry deal is the complete inverse. There will be marginal cost savings, but it's really about leveraging brand and accelerating revenue growth in both sides of our traditional storage business and Foundry's Ethernet business.

We have the opportunity to grow Foundry's product in more geographies, there's more opportunity for the traditional Brocade products to grow further into the federal space and into the service provider space where Foundry is strong. There will be more greenfield opportunities, too, as you have customers in the small to midsize enterprise market that are growing in scale and will hit the tripping point where they need a SAN.

The only real similarities between these two very different transactions is the fact that the names on all the buildings will be Brocade. The integration will be a very collaborative process. In the McData deal, none of their executives came over. You won't see that situation here. It's about acceleration, not cost-cutting.

How does buying Foundry help you compete with Cisco?

In terms of the competitive landscape for this deal, we believe our timing is perfect given how dynamic both the data networking and data center markets are right now. Based on the research we've done in due diligence, we know that customers are asking for more choice in terms of a credible, trusted option in end-to-end networking solutions.

With this deal, we are now that option. This deal creates a company with competitive scale and broad, global customer footprint. We believe this bodes well for us to be able to take on anyone in the networking space.

Is this in any way a defensive move on Brocade's part, as some have said?

I suppose it's easy enough for anyone to think that, but the facts don't bear this out. This is a deal of two strong, financially healthy companies in complementary markets coming together in an accretive, very financially healthy manner. Both companies share a passion for innovation and a commitment to developing and delivering customer-driven solutions. The deal adds scale and muscle for us to be able to grow and innovate even faster to take advantage of key market trends and emerging market opportunities. There's nothing defensive about that.

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