Brocade, McData to Merge

Brocade on Tuesday agreed to buy rival McData for $713 million in stock, a deal that will enable the storage gear maker to better compete with Cisco Systems in the market for storage equipment.

Brocade and McData make storage area network (SAN) switches, routers and software to help quickly and efficiently route data across storage arrays and other devices that store data to computers.

McData has struggled of late in what has largely been a three-horse race, with Brocade leading Cisco and McData by a wide margin in the total market for storage switches, according to Dell’Oro Group. In the first quarter of 2006, Brocade led the total SAN switch market with $178.5 million in sales, followed by McData with $107.8 million and Cisco with $79 million.

In the hotly-contested high-end modular switch market — traditionally McData’s strength — Brocade has been coming on strong there too. In the first quarter of 2006, according to Dell’Oro group, Brocade claimed second place for the first time in six quarters with $68.6 million in revenues. McData led with $76.4 million, and Cisco came in third with $64.7 million.

McData warned today that that it expects to report revenue of $150 million to $152 million for its second quarter, down from the company’s expected range of $170 million to $180 million. McData attributed the lag to weak sales in its high-end products. Brocade, meanwhile, said it expects to beat forecasts with quarterly sales of $188 million to $189 million.

Baird analyst Daniel Renouard said in a research note that McData’s “weakness is not totally surprising, given recent results from EMC and IBM, and likely share loss due to lack of 4Gb director.”

Buying McData turns a competitor into an integrated ally with a broader array of hardware and software, but it will also require a lot of reconciliation of overlapping products. For example, Brocade executives will have to decide how to incorporate McData’s Intrepid switches, routers and management software into its fleet of SilkWorm SAN switches and routers and Tapestry management software.

Brocade CEO Michael Klayko said on a conference call that Brocade isn’t ready to discuss how the integration will work just yet, but expressed confidence in the two companies’ ability to merge products and corporate cultures.

“We believe that the combination of Brocade and McData will significantly benefit our customers, our partners and our shareholders,” Klayko said, noting that the deal will enable Brocade to better help customers manage the growing glut of data in their corporate offices.

“It’s an important step that builds on Brocade’s vision for the next-generation data center, leveraging Brocade’s product innovation and operational discipline.”

Klayko said Brocade also expects to speed up its innovation and time-to-market cycles as a result of the purchase.

Arun Taneja, founder and consulting analyst at Taneja Group, said “the synergies can be real if they can rationalize the product line within the next 12 to 18 months, while keeping the user insulated. It is a non-trivial task but if they can do it, they would present a much stronger opponent to Cisco. I think the OEMs of Brocade and McData will also be very happy as it reduces their testing matrix by a third.”

Taneja said the combined company “can also help spread its wings beyond block storage into the file side, as exemplified by the acquisition of NuView and a few others.”

“I have expected a merger/acquisition for a while but frankly, expected Cisco to make the move,” said Taneja. “The only surprise is that it was Brocade.”

Challenges abound beyond coping with product overlap.

Brocade and McData sell gear to customers through a wide number of high-tech original equipment manufacturers, including IBM, EMC, Dell, HP and others, that buy the switches and routers and resell them with their storage arrays.

McData, an EMC spin-off, has faced some rough treatment by its former parent, resulting in price concessions and product delays.

After incorporating McData’s assets, the key challenge for Brocade will be protecting McData customers’ investments, as well as making sure that the original equipment manufacturers are happy with changes to packaging or pricing schemes.

But Klayko claimed the combination will drive better field support and service, as well as minimize operational costs and reduce product qualification time for OEMs.

Under the terms of the agreement, McData stockholders will receive 0.75 shares of Brocade common stock for each share of McData class A common stock and each share of McData class B common stock they hold.

Based on Brocade’s closing stock price on August 7, the transaction is valued at $4.61 per McData share.

Should the deal close in the first quarter of 2007, McData stockholders will own approximately 30 percent of Brocade.

After the closing, Brocade’s management team will maintain their current roles. McData CEO John Kelley will serve as an adviser to Brocade, which will retain its name and corporate headquarters in San Jose, Calif.

McData will become a wholly owned subsidiary of Brocade; two McData directors will join the Brocade board of directors.

Looking forward, Klayko said the acquisition of McData is expected to reap annual synergies of approximately $100 million, coming from both headcount and non-headcount-related expenses, by the fourth quarter of combined operations.

Shares of Brocade fell $1.22 to $4.91 in morning trading, the latest drop since the company’s name was dragged through the mud in the recent stock option backdating scandal.

Former Brocade CEO Greg Reyes and former vice president of human resources Stephanie Jensen were charged with finagling dates on certain stock options for personal gain.

Shares of McData gained 59 cents to $3.44, while QLogic shares gained on hopes that that company can add to its 4% market share.

Article courtesy of InternetNews.com, with additional reporting by Paul Shread of Enterprise Storage Forum.