Will the Sun Finally Shine on Ancor Communications?
By Herb Greenberg
Senior Columnist
8/20/99 6:30 AM ET
Fried-Day
The games people play: You know the old story. Little company, starved for cash, announces contract with giant company. Its stock reacts by zooming higher before investors ever get around to reading the fine print.
Such is the hype and hope behind Ancor Communications (ANCR:Nasdaq). This cash-starved Minnetonka, Minn., maker of fibre-channel switches that are used to deliver large amounts of data has never earned a penny in six years as a public company. Last year its deficit hit a staggering $14.5 million -- especially staggering when its revenue this year, at best, is expected to be just $15 million (and that's being generous).
But that's all about to change. Or so hope (pray?) investors.
Earlier this summer Ancor announced that it had struck a deal for Sun Microsystems (SUNW:Nasdaq) to buy and distribute its products. The news caused Ancor's stock to almost immediately quadruple before settling to its current price of 28 1/2, giving it a market value of $720 million. Seven-hundred twenty million bucks for a company that has barely any biz? How many switches can Sun sell, anyway? Quite a few if you listen to Ancor. Using figures supplied by International Data Corp., the company has been saying that the fibre-channel switch market could be worth $235 million in 1999, $558 million in 2000, $1.1 billion in 2001 and a whopping $1.7 billion by 2002.
Short-sellers aren't so sure; even if the market does grow, they note that Ancor isn't without competition. Brocade Communications Systems (BRCD:Nasdaq), its largest competitor, is expected to do about $75 million in rev this year, or about five times Ancor. Two others, privately held Vixel and Gadzoox Networks (ZOOX:Nasdaq), which recently went public, are expected to sell about $20 million worth of switches between them. (Both companies, by the way, only recently started selling switches.)
What's more, Ancor investors with half a memory recall Ancor's previous relationship with Sun. Sun helped co-develop with Ancor the very switch it now plans to distribute. Sun, in fact, was expected to be a customer for the switch a year ago, but backed out, causing Ancor's stock to drop to a low of 1 before recovering in the mid-single digits, where it stayed before the most recent Sun-related run-up.
Why did Sun return? Neither officials from Sun nor Ancor could be reached, but considering the terms of the deal, it would appear Ancor was desperate. The deal calls for Sun to get warrants to purchase 1.5 million Ancor shares at $7.30 per share. Dilution, anybody? Warrants, when exercised, can be terrible for investors. Ancor itself warns in several recent SEC filings that terms of the deal could cause gross margins to be "impacted significantly" as the warrants vest.
But wait, there's more: It's not yet even certain that Sun will go ahead and buy the switches because it's still trying to make sure they work with Sun's products. (If they don't, according to the documents, Sun can walk away from the deal.) Plus, the company warns that there's no guarantee Sun will stick around even if the switches do work with Sun products. If Sun does walk away, Ancor's "business would be materially harmed." Boilerplate, sure, but it's worth taking to heart in light of Sun's recent history with Ancor.
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