**Very bullish SmartMoney article. Is Your Fund Getting Its Fibre?
September 23, 1999
By Danny Hakim
DON'T CRY FOR Brocade Communications Systems
(BRCD) just because there's no dot-com attached to its
name. Since its May 24 IPO, the stock of this maker of
Fibre Channel switches (we'll attempt to explain later) has
soared 1,085%, which makes Brocade, in the parlance of
famed fund manager Peter Lynch, a "ten-bagger" in just four
short months. Already the company, which had just $20
million in revenue in the latest quarter, has a $6 billion
market capitalization.
That eye-popping performance merits Brocade a spot in our
series on hot IPOs and the funds that love them. Previously,
we covered e-commerce software company Ariba (ARBA)
(see story) and Phone.com (PHCM), a company that
makes software that connects portable devices to the
Internet (see story). But those two stocks have risen a
piddling 479% and 740%, respectively, since their 1999
IPOs -- chicken feed, compared to Brocade.
So what kind of business could possibly be worth a four-digit
percentage gain? Well, we turned to Brocade's Web site
and got the following explanation: "Brocade full-fabric switches and software connect servers with storage
devices through a Fibre Channel network." Uh huh. "This high-speed, reliable connection allows
companies to access and share storage in a high-performance, manageable, and scalable Storage Area
Network (SAN)." Right. "The switches provide full fabric support, true line-speed switching, and modular
components to build a wide range of SAN solutions." Got it.
OK, let's try that again. Brocade's "switch" is a rectangular, black box that
looks something like a typical stereo receiver or VCR, except for a series of
ports running across the front. These switches connect data-storage devices to
network servers via fiber-optic or copper cables. Earlier connection methods
allowed for "one-to-one" connections between a single server and a single
data-storage device over very short distances, but Fibre Channel switches allow
for a network of connections between a multitude of different data-storage
devices and servers over a few miles.
Brocade is one of several companies building parts for these nascent SANs, which allow companies
much more efficient and speedy ways to manage their accumulated data. Considering the Internet is
making the digital world a very crowded place, it's not hard to see why investors are enthused about
Brocade. Data is like garbage -- there's no shortfall in sight. Not surprisingly, companies that are figuring
out ways to store all this data have been hot investments. Last year, EMC (EMC), which makes
data-storage systems, ran up over 600%. This year, the hot pick is Brocade, which provides its switches
to such companies as IBM (IBM), Compaq Computer (CPQ) and Dell Computer (DELL).
"What is a surprise is how much enthusiasm we've had from investors," says Brocade CEO Greg Reyes.
"What's not a surprise is the company's performance. This is the next major networking category," he
says, citing a recent study from International Data Corp., that predicts the Fibre Channel switch market
will grow to $1.7 billion by 2002, from about $235 million this year. By most estimates, Brocade controls
over three-quarters of the market. Analysts expect Brocade to report a loss of seven cents a share on
revenue of $54 million in 1999.
But who cares about today's losses when the potential is so huge? Not Garrett Van Wagoner, one of the
year's hottest fund managers. He owns Brocade in all five of his mutual funds, four of which are among the
top seven domestic retail funds of 1999. Van Wagoner, a frequent IPO dabbler, also owns larger stakes in
Ariba and Phone.com, according to his June 30 report. His Van Wagoner Emerging Growth (VWEGX),
which owns all three, has climbed 141% so far this year.
Making much larger, proportional bets on Brocade, according to the fund-tracking firm Morningstar, are
the managers of Oak Associates in their Pin Oak Aggressive Stock (POGSX), up 38.7% year-to-date,
and Red Oak Technology Select (ROGSX), up 51.3%, as well as the manager of Ark Small-Cap
Equity (ARPEX), up 42.3%. Other fund holders include Northstar Growth (ADGRX) and Eaton Vance
Special Equities (EVSEX). Fund giant Fidelity also has Brocade sprinkled among plenty of its
growth-stock funds. In fact, Fidelity owns nearly 4% of the company's stock, making it Brocade's biggest
institutional owner, according to Securities and Exchange Commission filings data and Investment Data
Corp.
Individual investors have to consider that none of these funds made its purchases while Brocade was in
the 200s. So what do managers think, now that Brocade is up over 1,000% and trading at a
head-scratching valuation, 583 times its forward earnings? Depends on whom you ask.
"We got it at $50. Now it's at $250," said Red Oak co-manager Doug MacKay earlier this week. "We
bought Cisco Systems (CSCO) at 28 cents and never sold a share. [Brocade] is an expensive stock, but
this is the opportunity for a Cisco-like company. We haven't taken any chips off the table."
Gil Knight, manager of Ark Small-Cap, has taken chips off the table. "We bought it at $94, rode it up to
$130 and sold a little there, then sold more at $170," says Knight. "These guys are hot right now, but you
don't know what competing technology will come out. Things could change. You have to be careful how far
out you discount a company. The technology can change so rapidly. Right now it looks awfully
overvalued."
Analyst Steve Denegri of Morgan Keegan suggests the relatively overlooked Ancor Communications
(ANCR) as an alternative. While the Minnesota company only controls about 5% of the market -- a
fraction of Brocade's position -- Denegri particularly likes Ancor's recent deal with Sun Microsystems
(SUNW), which he says is the largest provider of Fibre Channel disk-storage devices.
"Why chase the one with the big valuation when you've got this underdog?" asks Denegri. "It's hard to give
Brocade gorilla status when Sun is in Ancor's camp." As for Brocade, Denegri respects the company's
commanding position in the market but gave it a neutral rating of Market Perform when he began covering
it in June. Back then, the company was at 84 3/4. So what does he think now that it's trading in the
200s?
"At this point, I don't think we're looking for an entry point," says Denegri.
And what does Brocade's CEO Reyes think? Like Red Oak's MacKay, he says: Think Cisco. "There are
people that looked at Cisco in the early '90s and said it was too expensive," says Reyes. "That was a
hundred billion in market cap ago."
SmartMoney.com ¸ 1999 SmartMoney. SmartMoney is a joint publishing venture of Dow Jones & Company, Inc.and Hearst Communications, Inc. |
