Is Brocade Out of Steam?
by Seth Martin
10:30:00 AM November 27, 2001 GMT
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Brocade [BRCD:Nasdaq] will report Q4 results after close of market on Wednesday. And while Brocade is still the definitive storage network fibre-channel switch leader, competition is growing. Thanks to a significant (147%) rise in the stock since October 1, we are lowering our rating to a Sell ahead of this report -- we believe the pressure to outperform the market is now too great to sustain the stock.
Brocade is expected to earn $0.04 per share, on sales of $110.8m. Gross margin should be slightly below 60%. Days sales outstanding (DSO) is likely to rise slightly from last quarters 57, due to some of the delays brought about by 9/11. But we do not expect the investment community to concern itself with such a rise.
So what would it take for the stock to make gains off the Q4 report? Well, maintenance of Q1 target would be a starting point. Brocade is currently expected to earn $0.04 per share, on revenues of $116m. At the very least, growing revenues sequentially next quarter would show that sales have already bottomed out.
If Brocade offered any real insight into the rollout of the Silkworm 12000, it could help the stock. Most beta testing of the director-class fibre channel switch by OEMs occurred in Q4, and some very early sales as well. The faster Brocade moves the 12000 into wider production, the better its position with OEMs – by digging into the director-class market where McData [MCDT:Nasdaq] has a resounding leadership position -- and of course the faster it will add to revenues. But Brocade will need to do more than simply offer vague optimism over the performance of the switch when it’s brought into wide production in the first half of next year to gain investor favor.
The SilkWorm 3800, its first workgroup (standard) switch able to transfer data at 2 Gbps, was introduced in the Q4, and so any expectations for performance of this lower-end non-director switch in the Q1 would also be helpful.
One thing that Brocade has going for it is widespread belief that storage networking is going to be the area of the storage market that recovers the fastest. And indeed, many innovations in storage networking have occurred since the stock market began heading south in 2000. Therefore it is expected that buyers will focus on new technologies in greater numbers when a rebound in the general economy occurs.
But even if that rebound occurred tomorrow, would it be worth it to own Brocade at 114 times next year’s expected earnings and 13.3 times next year’s sales? Not unless Brocade was facing zero competition in the director-class switch market, instead of an entrenched McData. Competition is going to be fierce, and profits may be sacrificed along the way. And Brocade knows this, so it’s unlikely to step up in the conference call and offer definitive 2002 guidance. Without such guidance, we would expect uncertainty to get the better of investors, and the stock to come under pressure.
Market Timing
From the Technical Desk
Brocade Communications [BRCD: Nasdaq] rallied off the Oct. lows and made gains of more than 200% in the last 8 eight weeks. Shares are currently overbought and we expect some consolidation in prices. Look for a retreat to $26.50 in two to four weeks. It is trading at $31.94.
Risk Tolerance ****
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