Brocade: Deal or no Deal?

October 12, 2009

rtri2ikIn an October 11 research note titled “Castles in the Air, Downgrading to Perform,” Oppenheimer & Co analyst Ittai Kidron throws cold water on expectations that Brocade will be bought anytime soon.

The speculation began last week, after The Wall Street Journal reported that Brocade was “quietly” shopping itself, and that Oracle and Hewlett-Packard could be potential buyers.

Later, Reuters reported more details: Brocade had in fact been trying to sell itself for several weeks, and HP had kicked the tires — going as far as to begin due diligence — but stopped short of making an offer for the company because they were only interested in certain assets. Then, Oracle CEO Larry Ellison publicly said his company wasn’t about to buy Brocade. Apart from HP and Brocade, analysts have speculated that IBM and Juniper Networks could also be interested.

Oppenheimer’s Kidron explains why Brocade might have trouble finding a buyer:

Brocade’s shares have risen sharply following WSJ reports the company has put itself up for sale. We, however, don’t anticipate a near-term acquisition. We view Brocade’s data center switching as the prime jewel, and it’s unlikely prospective buyers would pay a hefty premium for it solely.

Kidron then lists each potential acquirer and tells you why those companies won’t pick up Brocade. His comments are in quotes:

  • HP: “Risks losing substantial revenue given Brocade’s OEM exposure and material overlap with ProCurve. Only needs a data center switch.” In other words, HP might lose the revenue that comes from Brocade’s partnerships with companies that sell its products. Also, HP and Brocade already make some similar gear.
  • IBM: “Return to hardware business unlikely.” IBM has transformed itself from a hardware seller to a global services giant and we heard last week that IBM had decided not to look at Brocade’s books, although that could change.
  • Oracle: “Publicly denied interest.” Anyway, Oracle is waiting to get regulatory approval from the European Commission to proceed with its acquisition of Sun Microsystems.
  • Juniper: “Overlap with Foundry and too big to swallow.” Juniper is the No. 2 maker of network gear after Cisco and buying Brocade would add scale to its business, but would potentially bring integration challenges given Juniper’s size.
  • Dell: “A wild card but busy with Perot acquisition ($3.9B), limiting bandwidth.” Dell might agree with that (see below).

Dell’s Vice President of Enterprise Storage and Networking Praveen Asthana stopped by the Reuters office Monday morning, and here’s what he had to say about acquisitions: “We don’t want to overextend ourselves at any time.” Yes, Dell is more acquisitive now than it has ever been, but the PC and server computer maker still wants to focus single-minded on integration and implementation after it has bought a company, so “we wouldn’t want to do three large acquisitions at the same time. The main goal that we have is successful implementation. I’m sure we don’t want to add too many big ones at the same time.”

Kidron’s conclusion?

Given the M&A hurdles and premium Brocade is likely to demand, we’re doubtful of a deal near term. As such, we would take profits at current levels and are downgrading Brocade to Perform.

So far, Brocade shares haven’t reacted much. They were up 0.9 percent at $9.50 in early afternoon Nasdaq trading. Clearly, the market is still holding out hopes of a deal for Brocade, whose shares have risen about 24 percent since before news of its potential sale.

(Additional reporting by Ritsuko Ando. And yes, that’s a picture of a model wearing a brocade gown, courtesy Reuters. Because it makes for a better picture than networking gear.)

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