Brocade And McData Merge To Fend Off Cisco

In a move aimed at defending their positions in the storage-switching and director market against Cisco Systems, Brocade has agreed to acquire rival McData in a transaction valued at $713 million.

That represents a 48 percent premium over McData's Monday closing price and a 32 percent premium over its 50-day moving average, according to Enterprise Strategy Group.

Brocade and McData have long been competitors in the storage-switching market, but Cisco in recent years has launched a formidable challenge to both companies with its own line of SAN switches. Brocade's 2005 revenue was $574 million, 4 percent down over 2004, while McData's revenue was $614 million, up more than 50 percent over the previous year.

All three companies, as well as QLogic, are key providers of enterprise SAN fabric switches and directors, and have OEM relationships with most of the key providers of storage arrays, including EMC, Hewlett-Packard, IBM and Sun Microsystems.

But customers and systems integrators tend to specify their SANs based on specific switches, depending on data-center configuration and capacity requirements. Brocade and McData are both viewed as the leading suppliers of storage switches and directors, with the latter stronger in the high end of the market.

"While there is some overlap, there's also a lot of synergies," says Tony Asaro, an analyst at Enterprise Strategy Group. "Both of these guys realize there is a formable opponent in Cisco that has the brand and the relationships with nearly every company out there on every level, and they both needed to do something to rise to a higher level."

While Cisco has gained traction with its storage switches, the business remains immaterial to the company today, Asaro says.

"Cisco has barely made a business of it," he says.

Nonetheless, with its marketing clout, channel partners and relationships with customers and solution providers, Brocade and McData needed to become stronger, Asaro adds. Their challenge now will be in execution.

"Neither of these companies were lighting the world on fire," he says.

Brocade today announced preliminary third-quarter revenue of $188 million to $189 million, representing the high end of guidance. Meanwhile, McData today warned that revenue for the quarter ended July 31 fell short of the $170 million to $180 million expected, instead coming in at around $150 million. Net income also fell short at 2 cents a share. Estimates had McData ringing in 4 to 6 cents a share.

Brocade has been in the spotlight on a higher level after its former chief executive Gregory Reyes was the first CEO to be charged by the Securities and Exchange Commision with alleged fraud in a stock options probe that involves scores of companies. Reyes and another former executive each face up to 20 years in prison if convicted and a $5 million fine. Both executives have said they are innocent of the charges.

The boards of both companies have agreed to terms of the merger, which is expected to close in the first quarter of calendar year 2007, pending regulatory and shareholder approvals. The senior executive management team of Brocade is led by president and CEO Michael Klayko. McData chairman CEO John Kelley will serve as an adviser.