Brocade to acquire McData

Posted on September 01, 2006

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By Kevin Komiega

Brocade made a bold move last month and narrowed the playing field in the storage networking market when the company announced its plans to acquire chief rival McData. According to some analysts, the effects of the acquisition will be far reaching and could serve as a catalyst for the development of network-based storage intelligence, as well as increased adoption of iSCSI technology.

Under the terms of the deal, Brocade will acquire McData in an all-stock transaction valued at approximately $713 million. When the dust settles, McData’s shareholders will own about 30% of the new company.

The deal has been unanimously approved by the boards of both companies, but is still subject to approval by shareholders and the SEC. The acquisition is expected to be completed late this year or early next year. Brocade has found success in small and midrange environments, while McData’s stronghold has historically been in the high-end director market. The acquisition will not only give Brocade a bigger presence in large enterprises, but will also boost its software and services organization.

“Brocade doesn’t need help in the channel, which they’ve mastered, but they do need help in [capitalizing on] their acquisition of file virtualization vendor Nu-View and moving their whole portfolio into the enterprise marketplace,” says William Hurley, a senior analyst with the Data Mobility Group consulting and research firm.

“Our customers have been telling us they are frustrated by a lack of interoperability, and data growth compounds the complexity. Users want simpler and more-scalable solutions,” says Brocade CEO Michael Klayko. “We are going to provide a unified platform. Together we will provide the interoperability and management unification customers have been asking for.”

But there are a lot of decisions to be made before Brocade can start rolling out new products and platforms. The companies face the daunting task of eliminating overlap between their product portfolios and personnel.

“The issue of overlapping product lines is the huge variable,” says Mike Karp, a senior analyst with the Enterprise Management Associates consulting firm. “Rationalizing the product portfolios is absolutely crucial. There is probably a 90% overlap between the products.”

Furthermore, there are issues of redundancy beyond that of the two companies’ respective hardware and software lines. Karp says Brocade and McData also have similar sales models and distribution strategies. “There is also an overlap in the go-to-market model and the customer base. They have the same model of working through OEM partners, the same resellers, and basically the same products. There is also a lot of redundancy in sales and support,” says Karp.

Brocade and McData claim that the combined company will “generate annual synergies of approximately $100 million, coming from both headcount and non-headcount-related expenses.” In other words, the combined company will cut $100 million in operating costs once the acquisition is complete. But where is the savings come from?

Karp believes most of the savings will come from a reduction in personnel. Brocade currently employs about 1,160 people, while McData has about 1,447 people. It is unclear how many employees will make the cut.

McData will eventually become a wholly owned subsidiary of Brocade, although the two companies will operate as separate businesses until the deal is completed.

Meanwhile, Brocade seems to be steamrolling through the cloud of suspicion cast on it by the ongoing investigation by the SEC into allegations of criminal wrongdoing and securities fraud against former CEO Greg Reyes. The company announced record preliminary third-quarter earnings results on the heels of the McData announcement, to the tune of approximately $189 million. The numbers showed 3% growth from the second fiscal quarter and 54% growth over the same period in 2005.

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The combined company will have a dominant share of the Fibre Channel SAN switching market (see figure). According to a Gartner Inc. report released in June, Brocade raked in revenues of about $175 million in the first quarter of 2006, with McData banking approximately $100 million in the same time period. Cisco holds the number-three spot, with just over $80 million in Fibre Channel SAN switch revenues in the first quarter of this year.

However, Karp says Cisco is far from out of the race for storage networking supremacy. “Cisco’s MDS product line stacks up nicely against Brocade and McData, and Cisco has almost infinitely deep pockets.”

Originally published on .

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