It's always something with Brocade (Nasdaq:BRCD). Although takeover speculation gave a little life to the stock, the ongoing problems in the ethernet business and the sluggishness of the underlying storage market have sapped a lot of that momentum. Although Brocade remains a tech stock that could deliver substantial returns if it got all of its ducks in a row, progress towards that goal seems inconsistent at best.
SEE: Trademarks Of A Takeover Target.

Second Quarter Results Beat Slightly, but will Anyone Really Notice?
Relative to published sell-side estimates, Brocade delivered a pretty good second quarter. Unfortunately, ongoing issues in the ethernet business and disappointing guidance are likely to limit the enthusiasm over the quarter.

This quarter revenue did surpass estimates by a few million dollars, but nevertheless declined 1% from last year and 3% from the fourth quarter. Within product revenue, storage product revenue rose 4% from last year and fell 2% sequentially, while ethernet business revenue fell 10% year over year.

Brocade did do well on its margins. Gross margin improved on both an annual (up two points) and sequential (up half a point) comparison and was about two points ahead of where many sell-side analysts had modeled for the company. The company basically held that outperformance through its operating items, and operating income rose 13% from last year, while falling one quarter sequentially.

SEE: Analyzing Operating Margins.

A Little Added Color Doesn't Brighten the Story Much
Repeating what has become an unfortunately common theme, Brocade continues to struggle to build up its ethernet business. The company didn't appear to gain on Cisco (Nasdaq:CSCO), and Juniper (NYSE:JNPR) saw year-on-year growth where Brocade was down by double-digits. Uptake of the VDX line and 100GbE products has been good, which just highlights how weak the legacy business has become - even with the support of companies like EMC (NYSE:EMC).

On the storage side, the company's leadership in 16Gb continues to be a major factor in pushing the company forward. Unfortunately, this means that Brocade is weak where most investors see the most growth potential and strongest where most investors see a slowing (although not declining) legacy market.

The Bottom Line
Brocade deserves credit for maintaining such strong share in the SAN market, especially against a company like Cisco. Unfortunately, the ethernet business has never delivered on its potential, and investors have had to listen to a series of excuses, explanations and pledges for future improvements. With the SAN market offering a lot less growth than ADCs ((dominated by F5 (Nasdaq:FFIV)) or even WAN optimization ((where Riverbed (Nasdaq:RVBD) makes its home)), investors just aren't willing to pay much for this stock.

I honestly don't know what Brocade can do to improve the ethernet business, but I'm not confident they can do it all on their own, and I'm not sure that a small or medium-sized tuck-in deal is going to fix the situation either. Maybe Hewlett-Packard (NYSE:HPQ) or Dell (Nasdaq:DELL) could prove vulnerable, but some investors may have given up on Brocade's prospects in ethernet.

Buyout rumors keep popping up around Brocade, with Dell being a frequently named buyer. I have my doubts about that. Brocade's high-end market sales are tied to OEMs like IBM (NYSE:IBM), EMC and NetApp (Nasdaq:NTAP) that aren't likely to stick around if rival Dell buys Brocade.

SEE: Understanding Leveraged Buyouts.

That said, Brocade's valuation is undemanding. Even just 3% compound free cash flow growth and a higher-than-market discount rate points to a target price more than 50% above today's price. With nobody, yet, predicting actual declines in the SAN market, that seems like pretty modest expectations even with the ongoing ethernet struggles. Although tech stocks usually need revenue growth to really work, this may yet be a name to watch for value-oriented investors.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
Related Articles
  1. Entrepreneurship

    Top 10 Side Jobs You Could Start Now

    Ways to make extra cash in your spare time.
  2. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  9. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  10. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!