Brocade Communications Systems, Inc. (BRCD)’s Looking for M&A Love Ahead of Earnings

The key in the quarter was Brocade’s storage area networking, or SAN segment, which did extremely well. This is important to note because it was clear that Brocade stole market share from Cisco. The company’s SAN revenue grew 10% year over year with product revenue advancing 12%, helped by strong switch sales and fibre channel products.

Elsewhere, although Ethernet switch revenue was modest, with just 5% growth, it is outperforming Cisco’s core switching revenue, which has seen year over year and sequential declines. Plus, Brocade continues to do well with profitability. GAAP net income grew to $54 million, reversing the $4 million loss the company posted in the year-ago quarter.

Operating income grew 12% year over year as the company continues to benefit from improved gross margin, which advanced by almost 2% year over year and by 1% sequentially. Clearly, this is a company heading in the right direction and has plenty to offer, especially considering that Brocade has more than doubled its free cash flow position over the past five years.

The company has a market cap of just $2.6 billion and a solid balance sheet, which includes roughly $713 million and $600 million in manageable debt. That the company continues to grow market share in its core SAN business makes Brocade an attractive acquisition for companies like Cisco and Oracle, the latter which just picked off Acme Packet, Inc. (NASDAQ:APKT) for $2.1 billion.

Both Cisco and Oracle have the financial means to make this deal happen. For that matter, so does IBM. And lest we forget Juniper, for whom CEO Carney once worked. And there are compelling synergistic scenarios with each candidate. But will they make the deal?

Stock is cheap while the wait continues
On Thursday, Brocade will have another opportunity to market itself to suitors when it reports first-quarter earnings. The company had issued prior revenue guidance of $565 million to $585 million, with non-GAAP earnings per share to arrive at $0.15 to $0.16. However, and as with Q4, it will be the company’s performance in the SAN business that will be interesting to watch.

After all, this has been Brocade’s main business focus and the area that will make it the most attractive. The company guided for 3% to 6% sequential growth. If Brocade reaches the high range, this means that the company is expecting SAN revenue to arrive at around $420 million. Then again, this would only represent year-over-year growth of 3.5%. Would this be enough to entice Cisco or Oracle to pony up the cash?

It remains to be seen how long Brocade remains an independent company after the report. Then again, I spent all of 2012 trying to pair this company with a column A candidate. In the meantime, the stock is cheap. If not an M&A play, there’s certainly a value play here for investors, especially those with a high frustration threshold. As noted, the stock has not moved in more than a year.

However, with shares trading at $5.72, a case can be made why fair value should be $7 or $8. Remember, this is a company that has doubled its cash flow over the past five years. The buyout rumors notwithstanding, as long as Brocade continues to grow long-term free cash flow and make modest market share gains in its core business, the stock should command a higher premium — at the very least 20% more from current levels.

The article Brocade’s Looking for M&A Love Ahead of Earnings originally appeared on and is written by Richard Saintvilus.

Fool contributor Richard Saintvilus has no position in any stocks mentioned. The Motley Fool recommends Acme Packet, Cisco Systems, and VMware. The Motley Fool owns shares of International Business Machines (NYSE:IBM)., Oracle., and VMware.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.