Making Sense of BrocData
Brocade announced its acquisition of McData three weeks ago with great fanfare. The deal was going to save $100 million, create a broader range of solutions and services, accelerate the pace of innovation and benefit OEM partners. But what does all that really mean?
Brocade and McData speakers at a recent Webcast were guarded and hewed closely to their carefully tooled speeches, but McData CEO John Kelley expressed it best.
"When looking objectively at our ability to continue to invest to meet customer requirements, we believe that size, financial wherewithal, magnitude of customer installations and technological prowess are characteristics we must continue to incorporate into our future at a world-class pace," Kelley said. "This brings the best possible combination of strengths to meet these needs."
Or to put it another way, they both were terrified of Cisco, which has been neck and neck with Brocade and McData in the battle for director switch supremacy.
"There is no doubt the deal was influenced by the looming specter of Cisco," says Mike Karp, senior analyst at Enterprise Management Associates. "Cisco is a $20 billion dollar company with a big R&D budget, whereas McData and Brocade together are at around $1.5 billion."
Synergies or Layoffs?
One big selling point for the acquisition was the fact that it is supposed to generate synergies totaling $100 million in "both headcount and non-headcount based expenses," according to Brocade CFO Richard Deranleau.
But according to Karp's math, too much product redundancy probably means that much of the savings will be realized in terms of big layoffs.
"I'm not too sanguine about the acquisition, as the $100 million has to be mostly from headcount," he says. "That's not good news for my friends in Colorado."
Tam Dell'Oro, an analyst with Dell'Oro Group, has similar reservations. She presented detailed breakdowns of previous corporate marriages.
"Acquisitions are always tough to integrate, especially in large companies like this," she says. "If you look at history, it always takes time."
Her figures show that the sales level of an acquired company generally declines 30 to 70 percent in the quarter following the acquisition and stays there for the next five quarters. Only a few haven't gone that way.
One example she cites is McData's acquisition of InRange/CNT. InRange took in $80 million a quarter in mid-2005 and McData $100 million. The combined revenues fell to about $165 million only a 10 percent drop. However, she also points out that one year later, their combined income fell to $155 million. That's still only a 20 percent reduction, and the figure may have been affected by rumors of ongoing negotiations.
On the plus side of the ledger, she sees some method in the apparent madness. There is a common thread that runs through the InRange, CNT, McData and Brocade acquisition stream: professional services. InRange had significant presence in professional consulting and services.
"That was the diamond in the deal for McData, and these people have largely stayed at the company," says Dell'Oro.
She worked out that the revenues from consulting services are as good or better than before the CNT/InRange pickups. InRange recorded consulting and services totals in 2003 of $121 million. CNT then reported services revenues in 2004 of $129 million. For 2005, McData/CNT earned around $125 million. And in 2006, McData is hovering around $33 million a quarter. That equates to $132 million for the year. Yet prior to the merger, McData had a negligible services presence. The same holds true today for Brocade.
"The obvious conclusion is that McData retained the services intellect from the previous acquisitions," says Dell'Oro. "Brocade would be wise to do whatever it can to keep these services staff happy. This is an asset that Cisco does not have."
Winners and Losers
Both Karp and Dell'Oro agree that there is a tremendous amount of overlap among the product portfolios.
"Finding the economies of scale and making the synergies work won't be an easy task," says Karp. "These are ninety percent redundant technologies, without much that is complimentary."
So what will survive? Karp mentions whispers that McData's high-end switch, the Intrepid 10000, might be a big casualty. Dell'Oro backs this assertion up with some trademark number crunching. She highlights the excellent sales curve of the Brocade Silkworm 48000, which has doubled in sales over the last year to $69 million. McData's Intrepid, on the other hand, sold $76 million. So why keep the lower-selling model?
"Intrepid sales have been flat for eight consecutive quarters," says Dell'Oro. "So if I had to make a guess, I'd say Silkworm will stay."
Such conjecture, though, may or may not be accurate. Brocade marketing vice president Tom Buiocchi stated that integration planning has not even started yet.
"Both companies have specific strengths," he says. "There will eventually be a convergence point in our product sets, but that will be some time in the future."
So who will win when the dust settles? Michael Klayko, CEO of Brocade, mentions the value the merger brings to his major partners.
"This deal will be beneficial to OEMs, as they will find it less expensive to test and qualify their products," he says.
Dell'Oro highlights that both McData and Brocade sold quite a bit of equipment through the big three. EMC and IBM alone account for 67 percent of McData sales, while EMC, IBM and HP move 71 percent of Brocade's business.
"With them consolidating, these OEMs don't have to test both sets of equipment in the future," says Dell'Oro. "They will save millions of dollars. The question is, will they pass that on to the customer?"
What customers will gain, at the very least, is an easier time on the education front. No longer will they have to train staff on both sets of gear and tie up resources trying to make them interoperate. But less choice is not always a good thing.
"How would you like it if you only had one butcher shop to go to?" says Dell'Oro.
"We now have one less choice," says Karp. "Fewer competitors do not classically result in lower prices."
Karp believes the big winner in all this could be QLogic. While it doesn't have a competitive high-end product, QLogic offers plenty of low-end and midrange switches, as well as its extensive line of HBAs.
"Those looking for an alternative source might just pay more attention to QLogic," says Karp.
Buy or Wait?
So should users give Brocade and McData gear a wide berth until the dust settles? Or should they plunge in and see if they can get a good deal in the interim?
"Most people tend to hold off," says Dell'Oro. "They want an informed decision and generally prefer to wait it out."
Unfortunately, this attitude often spills over to competitive offerings too. Thus, the fallout from the merger could also adversely affect sales of Cisco switches. As a result, there are likely to be bargains to be had as these companies seek to bolster sales in what could be a temporarily weakened market.
For those in desperate need or those willing to take a gamble, what should be done? Both Karp and Dell'Oro emphasize longevity.
"The lifecycle of data networking equipment is around four years," says Dell'Oro. "Companies generally stand behind their products for this length of time or more, so whatever people purchase now, they should be fine."
Karp takes that a step further.
"If you buy anything from any company at this time, make sure you get in writing that the product will be supported for four years," he says. "That must cover tech support as well as the keeping of adequate spare parts."
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