Financial

posted on 22 July 2008 08:03

Brocade is buying Foundry Networks and so moving up from welterweight to light heavyweight in its competition with networking giant Cisco. The cost? A cool $3,000,000,000.

Finance Angle

Brocade will pay a combination of $18.50 of cash plus 0.0907 shares of Brocade common stock in exchange for each share of Foundry common stock. The deal is expected to start adding to Brocade’s earnings in fiscal 2009 and accelerate in fiscal 2010. It will also double Brocade's market capitalization from around $3 billion to $6 billion.

The cash will come half from Brocade’s cash in hand - and Foundry's cash in hand - and half from a loan from the Bank of America and Morgan Stanley Senior Funding. It’s clear that these institutions see the value in the deal in these credit-crunch-affected times.

The deal is expected to close by the end of the year once shareholders and regulatory authorities approve it. The resulting company will retain the Brocade name and current Brocade CEO Michael Klayko will remain the CEO.

Why is Brocade Buying Foundry?

In the general networking area there is Snow White (Cisco) and seven or many more dwarves (Blade Network Technologies, Extreme, Foundry, Juniper, Riverbed, etc.) None of them can realistically grow to Cisco’s size on their own. They have to consolidate to grow or else stay stunted.

Brocade is obeying the marketing mantra: get big (Cisco), get niche (Blade Network Technologies, Riverbed), or get out.

Michael Klayko said: "We believe the industry is at an inflection point in the way enterprise and service provider networks and data centers are being architected. Customers are demanding networking solutions that meet the needs for today and can address the many advances in network convergence that are still ahead."

Brocade sees that unified data center networking, the convergence of Fibre Channel storage area networking (SAN) via FCoE (Fibre Channel over Ethernet) onto an Ethernet transport layer that already carries network-attached storage (NAS) alongside LAN, Metro and WAN traffic represents both a tremendous opportunity and a tremendous threat.

Brocade knows about the power of consolidation, having seen in the SAN world CNT go into McData, which it absorbed itself. Consolidation is a terrific strategy for the consolidator.

The data center fabric convergence represents a bridge across which can come Cisco intent on gobbling up Brocade, or across which Brocade can venture, strengthened with Foundry armour plating. It's following the Star Trek idea and boldly going across the bridge.

Why is Foundry Selling?
Foundry is a profitable company. Revenue for the first six months of 2008 was $310.7 million, compared to $279.1 million for the first six months of 2007, an increase of 11%. Net income for the first six months of 2008 was $32.2 million, or $0.21 per diluted share, compared to net income of $24.7 million, or $0.16 per diluted share, for the same period in 2007.

Then why is it selling? Bobby Johnson, Jr., Foundry’s president and CEO, said: "Brocade and Foundry bring complementary strengths to the table in terms of technology leadership, product portfolio, and the ability to capitalize on key market trends.”

Foundry is in a weak position long-term and it knows it cannot benefit from a convergence of storage area networking and LAN/WAN networking because it doesn’t have the SAN products. Brocade does and Brocade is early into converged fabric networking. Both companies perceive that Brocade’s customer base is a terrific platform from which to build out into general data center networking.

Foundry cannot become a master of the networking universe on its own but it can share in Brocade's becoming a master of its universe.

What is Brocade Buying?

Brocade is buying the Foundry Networks product and technology set: enterprise and service provider switching, routing, security, and application traffic management products including edge and backbone Ethernet switches, Web and content-aware application switches, network-wide security, wireless LAN and access points, wide area access routers and internet provider edge and service provider core MPLS routers. Foundry's customers include the world's premier ISPs, Metro service providers, and enterprises including e-commerce sites, universities, entertainment, healthcare, government, financial, manufacturing companies, technology, and high-performance computing (HPC) sites.

This is an across-the-networking-board product and service set that can be combined with Brocade’s Data Center Switch product. Brocade is also buying Foundry's channels, sales force and customer base. There will be opportunities for operational synergies and a need for a huge and sustained technology rating and convergence effort.

What do Analysts Think?

They generally approve. For example, Zeus Kerravala, A Yankee Group SVP, said: "Brocade has now uniquely positioned itself in the networking industry to deliver a leading, alternative solutions portfolio spanning local, metro, wide and storage area networks. The breadth and depth of this portfolio make Brocade a viable option for customers looking for complete networking solutions capable of addressing their constantly evolving and increasingly complex IT challenges."

‘Alternative’ signals an alternative to Cisco.

Another analyst, Aaron Rakers at Wachovia, suggests that Brocade has paid a premium because Foundry is profitable and wonders if there will be problems in combining Brocade's primarily OEM-focussed sales channel and Foundry's indirect channel. Another question for him is how the acquisition will be seen at HP, Brocade's largest customer, which has its own ProCurve networking division, a competitor to Foundry.

Summary

The deal represents a highly determined and controlled aggressive move by Brocade. It shows the clear strategic sense of Michael Klayko and his ability to persuade his company and Foundry that a combined LAN, WAN, NAS and SAN technology base is the only way to deal with the Cisco facts of life in data center networking.

He has now parlayed Brocade’s SAN strength into a potential great technology and product base spanning both sides of the data center fabric convergence trend. Terrific move. Great potential. Plaudits all round.

^{[Chris Mellor.]}