The hicks weigh in:
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Brocade Communications Systems, Inc. (BRCD – 30.34) August 16, 2001
Ashok Kumar, CFA, 650-838-1414, akumar@pjc.com
Elvis Has Left The Building; Reducing Estimates
Rating: Neutral, Aggressive (#)
Price: $30.34 52-Week Range $133.75 - $16.75
FY End: October
Shares Out (Mil) 228.0
EPS 2000 2001E 2002E Market Cap (Mil) $6,917.5
Jan $0.03 $0.13A NA Average Daily Volume (Mil) 11.4
Apr $0.06 $0.05A NA Book Value $2.29
Jul $0.08 $0.05A NA Dividend Nil
Oct $0.11 $0.05E NA Debt/Total Cap Nil
FY $0.28 $0.28E $0.35 3-5 Year EPS Growth Rate 25%
FY P/E 108.4x 108.4x 86.7x Mkt. Cap. /FY01 Revenue 13.4x
Mkt. Cap. /FY02 Revenue 11.5x
Revs ($Mil) 2000 2001E 2002E 02 P/E to Growth Rate 3.4x
Jan $42.7 $165.0A NA
Apr $62.1 $115.2A NA
Jul $92.1 $116.3A NA
Oct $132.1 $120.0E NA Quarter End October 2001
FY $329.0 $516.5E $600.0 Est. Reporting Date November 2001
Tables may not add due to rounding.
Highlights
· July quarter results in-line with consensus expectations.
· Reducing estimates for the October quarter from $130M and $0.07 to $120M and $0.05. For FY02 our estimates are reduced
from $670M and $0.45 to $600M and $0.35.
· Stock discounts unrealistic expectations.
Brocade reported July qtr revenues of $116.3M, up 26% Y/Y and 1% Q/Q, in-line with expectations. Revenues seem to have
stabilized at these depressed levels. Pro forma EPS of $0.05 was in-line with consensus estimates. Our channel checks indicate that
SAN implementation continues to remain anemic due to weak IT spending, glut in storage capacity, and lack of compelling TCO
benefits. As such, we have reduced our FY02 estimates from $670M and $0.45 to $600M and $0.35.
Gross margins were stable at 60% due to favorable component costs and long-term pricing contracts. But we expect the network
storage vendors to share the pain of EMCs aggressive pricing strategy. EMC, and other system vendors, are expected to squeeze
component suppliers to reduce overall costs. We believe that the Company’s expectations of stable margins are unrealistic.
We estimate that the company shipped about 400 2Gb switches (Silkworm 3000) to OEMs and channel in the quarter. About half the
deferred revenue ($13.4M) was related to this product. However, 2Gb products are not a factor in the marketplace today and we do
not see adoption for another 12 months. There is not much of a demand pull as even the 1 Gb platforms are not being fully utilized.
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The Silkworm 12000, multiprotocol switch fabric, is expected to enter beta soon with production shipments slated for early 2002.
However, the Company is expected to face stiff competition from Cisco (Andiamo) and a host of private companies. The Company’s
ability to penetrate high end of the market and move up the value chain remains uncertain. The Company also faces increase
competition in its core market with McData’s entry into the edge switch segment.
While B/S remains strong, the Company has elevated inventory levels at its contract manufacturer – Solectron. The $8M end-of-quarter
in-house inventory does not fully reflect the significant off-balance sheet inventory commitment. At the end of the July
quarter, Brocade had outstanding inventory purchase agreements of $69.2M. Third-party inventory commitments were $20.2M. We
believe that effective inventory days at Brocade stand at more than six months, up from the two months in October. There is a real
risk that margins could be impacted by inventory writedowns.
The stock currently trades at 12x FY02 sales and about 90x FY02 EPS estimates. At a 3.4 PEG, the stock trades well above its peers
– EMLX (1.4x - #), MCDT (0.8x), and QLGC (1.0x - #). Assuming the current valuation holds, the Company would have to grow
revenues about 50% CAGR to support a 20% stock appreciation annually. This is an unlikely event under any scenario. |
