3 Things to Watch With Brocade Communications

Brocade Communications (Nasdaq: BRCD  ) manufactures IP-based Ethernet networking switches and solutions, as well as storage area networking solutions.

Today, let's look at three things investors should be watching regarding Brocade Communications, as they will provide us better insight into the company.

1. Buyout chatter
Normally when listing three things to watch regarding a specific company, buyout speculation will be No. 3. However, with Brocade clearly trying to find a buyer, takeover speculation is absolutely the most important thing shareholders should keep their eyes on.

Brocade originally piqued the interest of Blackstone Group in early February, but a deal was never drawn up. Since that time, other analysts have speculated that Oracle (Nasdaq: ORCL  ) or IBM (NYSE: IBM  ) would make a good fit. IBM makes a lot of sense to me given that Brocade has supply partnerships already in place with IBM, as well as Hewlett-Packard and Dell. Brocade isn't particularly pricey and is cash flow positive and would give IBM a chance to internalize some of its switching costs. If Oracle were to purchase Brocade, it'd gain a new line of networking products and give it a better footprint in its running hardware war against Cisco Systems (Nasdaq: CSCO  ) .

My Foolish colleague Anders Bylund sees it differently and thinks storage specialist EMC (NYSE: EMC  ) would be wise to scoop up Brocade. No matter how you cut this, Brocade has been working with Frank Quattrone's Qatalyst Partners to find a buyer and that plan still looks firmly in place.

2. Innovation, innovation, innovation!
The tech sector has one basic rule: Innovate or die! Sure, "bring in more than you spend" is an important rule as well, but in the end a lack of innovation will doom a business (just ask Research In Motion shareholders).

Brocade is constantly trying to improve its networking solutions, but it's also made some very poor decisions in the past that it's still trying to cope with. For instance, Brocade purchased Foundry Networks for an obscenely expensive $3.4 billion in 2008 in order to get access to the Fibre Channel switch market. Brocade, thinking it had found a new lucrative money-making stream, was distraught to find out that Cisco Systems was commanding just as much, if not more, attention from its big investment in Fibre Channel over Ethernet switches with an investment of $1 billion. Cisco's deep pockets and bountiful partnerships have made the switching market a very competitive sector for Brocade.

One area Brocade does stand to make significant strides is in networking infrastructure as it relates to the cloud. Last year Brocade introduced its Brocade Networking Solutions, which allows cloud operators to be billed monthly. Similar to Amazon.com's pay-as-you-go platform, Brocade's BNS could be a key growth driver.

3. CEO transition
The last factor worth keeping an eye on with Brocade is its current management transition. After leading the company for the past seven years, CEO Mike Klayko announced his intentions to step down as soon as Brocade's board of directors finds a suitable replacement.

The move to leave now is somewhat questionable given that Brocade's latest earnings report highlighted that the company is once again moving in the right direction. As resident Foolish tech junkie Anders Bylund noted as well, adjusted earnings gross margin has expanded rapidly to 5.8% from just 1.9% in the past four quarters. In addition, Brocade is solidly profitable and has been aggressively repurchasing its own shares.

Some on Wall Street have speculated that Klayko is leaving because of his inability to get a deal done to sell the company after trying for two years. Personally, I wouldn't rule out the possibility that a deal may be near and Klayko simply didn't want to take a demotion to a non-CEO role. Either way, a consistent message from management is important, and it will pay for shareholders to keep an eye on Brocade during this transition period.

Foolish roundup
Now that you know what to watch for, it should be easier to analyze Brocade's successes and pitfalls in the future and hopefully give you a competitive investing edge.

If you're still craving even more info on Brocade Communications, I would recommend adding the stock to your free and personalized watchlist so you can keep up on all of the latest news with the company.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on Motley Fool CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of EMC, Cisco Systems, Oracle, International Business Machines, and Amazon.com. Motley Fool newsletter services have recommended buying shares of Amazon.com, as well as creating a synthetic long position in International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's switching things up and making everything transparent.


Read/Post Comments (3) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 27, 2012, at 3:42 PM, brocadeFTW wrote:

    Sean, you need to do your research before writing.

    [QUOTE]

    For instance, Brocade purchased Foundry Networks for an obscenely expensive $3.4 billion in 2008 in order to get access to the Fibre Channel switch market. [/QUOTE]

    Brocade bought Foundry to get access to the IP switching/routing market. Brocade was the SAN/Fiber Channel Market leader before purchasing Brocade, pretty much the only show in town when it came to FC switches.

  • Report this Comment On August 27, 2012, at 4:09 PM, brocadeFTW wrote:

    Looks like I need to check my work before submitting too.

    Brocade bought Foundry to get access to the IP networking market. Brocade was the SAN/Fiber Channel Market leader before purchasing Foundry Networks. Brocade was pretty much the only show in town when it came to FC switches.

  • Report this Comment On August 29, 2012, at 6:52 AM, DiggerandSydney wrote:

    As per the comments above, do your research before posting what is supposed to be informed comment. Brocade were and still are the massive market leaders in FC SAN - anywhere up to 80% marketshare depending on whose version of stats you choose to use - De L'Oro constantly change the parameters they use depending on how much Cisco twist their arm for instance..........

    As far as the Foundry acquisition goes, the purchase cost was more like $2.4bn, so you are $1bn out. Not great but the principal of the comment is right in that it was way too much - $1.5bn may have been about right.

    Finally, Klayko's departure is a matter for conjecture right now and all of the mooted reasons could be right. One that has not been floated is that he has a greater and greater involvement in philanthropic ventures in Silicon Valley and it may well be that he is heading off into some quasi-political role with these sort of motivations at the root of it all.

    Brocade may well be a target for any of the big systems vendors without a full networking hardware portfolio, but the FC SAN part is the attraction and the problem as it will compromise the relationships with all the vendors who do not buy the company unless the purchaser can do as good a job as EMC has done with VMWare in keeping the business separate. Come to think of it, if they can do that with VWare, could they not do that with Brocade?!!..................VCE is a total crock and EMC will fall out with Cisco, like everyone else has, when they realise the true nature of their partnering strategies; they will need to have this up their sleeve and the reality is that this could ultimately be the most obvious move that they never actually make.

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