Tickers in this Article: BRCD, CSCO, HPQ, JNPR, DELL, EMC, IBM, NTAP, FFIV, ARUN
Brocade (Nasdaq:BRCD) is another one of those small tech stocks beset by worries that the market is changing out from underneath them, and that the Goliaths of the tech space ((Cisco (Nasdaq:CSCO), Hewlett-Packard (NYSE:HPQ), Juniper (NYSE:JNPR) and Dell (Nasdaq:DELL)) are going to chew away their business. Certainly the recent performance of the company and the valuation of the stock suggest little optimism, but this may yet be a name to consider for aggressive turnaround investors. Although this quarter's beat and raise proves nothing, at least there are some positive marks in the ledger for 2011.

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An Encouraging End to the Year
Brocade's results for the fourth quarter were not all that impressive at first look. Revenue was basically flat with last year and up 9% on a sequential basis. Storage area network (SAN) revenue was down about 4% from last year, with the smaller IP business offsetting that with 11% growth. Still, Brocade beat the consensus guess of year-on-year revenue decline, and surpassed the high end of the range as well.

Profitability was also a little better. Gross margin improved a bit from last year, though declined from the third quarter. Operating income (on a generally accepted accounting principles basis) rose 1% from last year and rebounded nicely from the third quarter, but margins still sit at a less-than-impressive 10%. (For related reading, take A Look At Corporate Profit Margins.)

Foundry Finally Paying Some Dividends?
One of the arguments for buying Foundry Networks for nearly $3 billion back in 2008 (apart from diversifying the company away from the sole reliance on storage markets), was the cross-selling opportunities in selling SAN and IP switches and routers to the same customers. At long last, maybe that is actually starting to happen to a meaningful degree. If the company can continue this trend of successful cross-selling, the incremental margin opportunities could be impressive, and it could help stave off threats from the likes of Juniper, HP and Dell.

Sustainability a Big Question
The trouble with this quarter is the question of whether it will be sustainable. It is not as though Brocade has not had good quarters before (only to struggle later on), and Federal spending is a volatile unknown. Still, relative to the likes of Dell, HP and NetApp (Nasdaq:NTAP), Brocade not only delivered a strong quarter but encouraging guidance as well - and at this point, Brocade shareholders are not likely to want to look a gift horse in the mouth.

A Familiar Problem
In some respects, Brocade is a lot like F5 (Nasdaq:FFIV) and Aruba (Nasdaq:ARUN) - small companies that have carved out interesting markets against the behemoth that is Cisco. Unfortunately for Brocade, this company has not been generating the same sort of growth, and the underlying markets are not quite as powerful. Still, I would not underestimate Brocade and its original equipment manufacturer partnerships with the likes of HP, IBM (NYSE:IBM) and EMC (NYSE:EMC). Said differently, if you sell enterprise storage products, EMC is a good partner to have onboard. (For related reading on investing, see 7 Controversial Investing Theories.)

The Bottom Line
Brocade has rebounded fairly well from the disappointments that surrounded poor guidance and Dell's acquisition of a rival company a few months ago. What's more, new product families, like 16GB products and virtual cluster switching, seem to be getting a real look from customers and Brocade has a large exploitable market with the growing interest in cloud computing.

Brocade is an interesting trade-off with risk and reward. Assuming just single-digit revenue growth and modest margin improvement suggests the stock is undervalued enough to be worth a buy. But, this is not a company that has shown it has any sustainability to its financial performance, and Cisco, Juniper, HP and Dell would be happy to take away shares from Brocade.

By the time the sustainability question is resolved, it will be too late to make much money from this stock, so investors have to take their chances on this one - the rewards are certainly there if the business improves, and there should be some floor in the stock from buyout rumors even if performance flags again.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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