Brocade Poised to Rise 40% in Takeover Seen for Oracle: Real M&A

Brocade Communications Systems Inc. (BRCD) is throwing off so much cash it may be worth 40 percent more in a sale to Oracle Corp. or private equity firms.

The maker of switches for data-storage networks, which had been trying to find a buyer with the help of Frank Quattrone for two years, was valued yesterday at 7.7 times its free cash flow, according to data compiled by Bloomberg. That was the cheapest among its closest competitors and less than half the median of 17 times for comparable companies -- even after surging almost 80 percent from its low in August to $5.77 a share.

While Brocade was passed over when Dell Inc. agreed to buy Force10 Networks Inc. in July, the company could give Oracle (ORCL) a networking product it currently doesn’t offer to businesses and enable it to better compete with Cisco Systems Inc., according to ThinkEquity LLC and Avian Securities LLC. Brocade, which has more than doubled its free cash flow in the past five years, also makes sense for buyout firms and could command about $8 a share in a takeover, ThinkEquity said.

“The cash flow is pretty healthy,” Rajesh Ghai, a San Francisco-based analyst at ThinkEquity, said in a telephone interview. “It could be private equity or a large strategic buyer. It fills a hole that Oracle has.”

Pavel Radda, a spokesman for San Jose, California-based Brocade, declined to comment on whether it is currently seeking to sell the company. Deborah Hellinger, a spokeswoman at Oracle, declined to comment on whether the Redwood City, California- based company is interested in buying Brocade.

Today’s Trading

Brocade climbed 2.1 percent to $5.89 in New York today, the highest level since July.

Founded in 1995, Brocade sells the hardware that connects information stored in servers. It controls 38 percent of the market for switches used in so-called storage area networks, a larger proportion than any of its competitors, according to Redwood City-based research company Dell’Oro Group.

Brocade also acquired Foundry Networks Inc. in December 2008 to enter the market for so-called ethernet switches that are gaining popularity in data centers.

The company has thus far been unsuccessful in selling itself, even after hiring Quattrone’s Qatalyst Partners to drum up interest, a person with knowledge of the matter, who wasn’t authorized to speak publicly, said in July. First-round bids in the latest auction for Brocade were due last month, according to people with knowledge of the situation, who declined to be identified because the process was private.

Relative Value

Sally Palmer at San Francisco-based Qatalyst didn’t return telephone or e-mail messages seeking comment.

At yesterday’s price, Brocade traded at 7.7 times its cash from operations of about 75 cents a share after deducting capital expenses, according to data compiled by Bloomberg.

QLogic Corp. and NetApp Inc. (NTAP), the two cheapest competitors among comparable companies cited by JMP Securities and Mizuho Securities USA Inc., were valued at 9 times and 11.2 times.

Less than a year ago, Brocade sold for 27.8 times its free cash flow, more than three times its current value.

Oracle could acquire Brocade to bolster its enterprise software and server businesses by adding networking products, which it currently lacks, according to Matt Bryson, a Boston- based analyst at Avian Securities.

Brocade may also make sense for Armonk, New York-based International Business Machines Corp. as it competes with Hewlett-Packard Co. (HPQ) and Dell for customers that want services from a single provider, according to Jitendra Waral, a technology hardware analyst for Bloomberg Industries.

‘Missing Networking Plugs’

Doug Fraim, a spokesman for IBM (IBM), didn’t return telephone and e-mail messages seeking comment.

“Everybody’s trying to stick to one vendor that can provide everything, rather than disparate systems,” Waral said in a telephone interview from Las Vegas. “IBM and Oracle both have these missing networking plugs.”

Brocade’s client partnerships could make a takeover less attractive, said Brian Marshall, a San Francisco-based analyst at ISI Group. One reason is that 60 percent of Brocade’s data- storage products, which account for more than half of its sales, are sold through agreements with Oracle, IBM and Hewlett- Packard, he said. If Oracle or IBM bought Brocade, the deals with the other two would probably end.

“They’d be selling products to a competitor, which could create problems,” he said in a telephone interview.

Aging Technology

The technology that Brocade uses for most of its data- storage products is also aging, which may also deter some potential buyers, according to Erik Suppiger, a San Francisco- based analyst at JMP Securities.

Brocade could still attract interest from private equity buyers, according to Joanna Makris, an analyst at Mizuho Securities USA in New York. The amount of free cash it generated last fiscal year climbed to a record $352 million, versus $136 million five years ago, data compiled by Bloomberg show.

The company’s operating margin of 8.9 percent was a third less than the median for comparable companies.

“Brocade is not getting a lot of love from investors,” she said in a telephone interview. “Private equity is usually the type of place where they take on stories like this.”

Based on ThinkEquity’s projected takeover price of $8 a share, Brocade would be worth $3.64 billion. That’s a windfall of about a billion dollars, data compiled by Bloomberg show. The price could rise even more if Brocade attracts multiple bidders, Penn Capital Management’s Eric Green said.

Traders in the options market are also getting more bullish on Brocade. The ratio of calls to buy Brocade shares versus puts to sell rose 46 percent to 1.11-to-1 on Jan. 9, the highest level since June, data compiled by Bloomberg show.

“This is one where you could have a bidding war,” Green, a Philadelphia-based manager at Penn Capital, which oversees $6 billion and owned shares of Brocade as of Sept. 30, said in a telephone interview. “It’s a stock that makes sense as an acquisition candidate and a lot of people would be interested.”

To contact the reporter on this story: Charles Mead in New York at cmead11@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net.

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