Brocade Faces A Firing Squad
Stocks: (BRCD)(MCDT)(MCDTA)
Brocade’s announcement that it would buy McData, which make switches for data storage systems, sent investors running for the exits. Brocade argued that having the broader product line that the combined company could offer would drive higher sales. McData shareholders will end up with about a third of the combined company.
Brocade’s stock fell over 18% on the news, down to $5. The company’s stock has been as high as $7.10 this year. McData rose 5% on the news to $3.29, just above its 52-week low of $3.01
The drop in Brocade’s stock is odd, because the deal looks pretty good. The company’s argument that it needs a broader product line is fairly clear. The Wall Street Journal made the observation that Cisco was getting into Brocade’s business of data storage network solutions, so the company almost certainly needs more weapons to stay in the game.
Beyond that Brocade trades at 2.7 times revenue. McData trades at 70% of revenue, so the price for McData is pretty low.
Skeptics will argue that McData is a bit of a dog. Revenue for the past three calendar years has gone from $328 million in the period ending Dec 02, to $419 million in the period ending January 04, to $400 million in the period ending January 05. Revenue has flattened over the last four quarters with a top line of $168 million in the quarter ending April 30, 2006. McData had an operating loss for that period of $8.5 million.
McData’s cash and short-term investments are $406 million and its debt, including the portion that is currently due is $372 million, so there is no balance sheet play here.
The deal is also not being driven by McData’s near-term future. The company guided down to $151 million for the current quarter. However, Brocade did say that the deal would be accretive on a “pro forma” basis by the fourth quarter.
Brocade’s business has been doing well. In the quarter ending January 28, revenue hit $179 million and operating income was $12.6 million. To get a similar revenue run rate at McData, Brocade is giving up a third of the company. On that basis, it may not be a bad deal especially because the combination should save about $100 million a year in expenses.
But, the truth of the reason behind the move is simple. Brocade is not a large company. Neither is McData. Since Cisco’s name came up in every press account of the deal, the two companies have a common enemy.
Brocade’s move was smart, very smart. It paid a small multiple for the revenue, customers and intellectual property it is getting. And, if the deal was not an option, Brocade was probably looking at a stock price well below where it trade now, maybe within the next year or two.
Sometimes a deal that allows a company to live to fight another day is a good one.
Douglas A. McIntyre can be reached at douglasamcintyre@gmail.com. He does not own securities in companies that he writes about.
Brocade’s announcement that it would buy McData, which make switches for data storage systems, sent investors running for the exits. Brocade argued that having the broader product line that the combined company could offer would drive higher sales. McData shareholders will end up with about a third of the combined company.
Brocade’s stock fell over 18% on the news, down to $5. The company’s stock has been as high as $7.10 this year. McData rose 5% on the news to $3.29, just above its 52-week low of $3.01
The drop in Brocade’s stock is odd, because the deal looks pretty good. The company’s argument that it needs a broader product line is fairly clear. The Wall Street Journal made the observation that Cisco was getting into Brocade’s business of data storage network solutions, so the company almost certainly needs more weapons to stay in the game.
Beyond that Brocade trades at 2.7 times revenue. McData trades at 70% of revenue, so the price for McData is pretty low.
Skeptics will argue that McData is a bit of a dog. Revenue for the past three calendar years has gone from $328 million in the period ending Dec 02, to $419 million in the period ending January 04, to $400 million in the period ending January 05. Revenue has flattened over the last four quarters with a top line of $168 million in the quarter ending April 30, 2006. McData had an operating loss for that period of $8.5 million.
McData’s cash and short-term investments are $406 million and its debt, including the portion that is currently due is $372 million, so there is no balance sheet play here.
The deal is also not being driven by McData’s near-term future. The company guided down to $151 million for the current quarter. However, Brocade did say that the deal would be accretive on a “pro forma” basis by the fourth quarter.
Brocade’s business has been doing well. In the quarter ending January 28, revenue hit $179 million and operating income was $12.6 million. To get a similar revenue run rate at McData, Brocade is giving up a third of the company. On that basis, it may not be a bad deal especially because the combination should save about $100 million a year in expenses.
But, the truth of the reason behind the move is simple. Brocade is not a large company. Neither is McData. Since Cisco’s name came up in every press account of the deal, the two companies have a common enemy.
Brocade’s move was smart, very smart. It paid a small multiple for the revenue, customers and intellectual property it is getting. And, if the deal was not an option, Brocade was probably looking at a stock price well below where it trade now, maybe within the next year or two.
Sometimes a deal that allows a company to live to fight another day is a good one.
Douglas A. McIntyre can be reached at douglasamcintyre@gmail.com. He does not own securities in companies that he writes about.
posted by douglas mcintyre at 5:19 AM
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