Storage Vendors Go Into Hock
In the past three months, seven storage networking companies have amassed $1.2 billion in debt -- and analysts say
the activity could mean consolidation is looming in the industry.
The most recent to latch on to this trend is Adaptec Inc. (Nasdaq: ADPT - message board), which yesterday said
it's seeking to raise $250 million through convertible bonds (see Adaptec Plans to Raise $250M).
That follows similar transactions by Brocade Communications Systems Inc. (Nasdaq: BRCD - message board),
Emulex Corp. (Nasdaq: EMLX - message board), and CNT (Nasdaq: CMNT - message board), which have each
issued their own debt offerings (see CNT Prices Its Notes, Emulex Slips in After-Hours, and Brocade to Raise
$500M in Bond Offering). Smaller players, including Gadzoox Networks Inc. (Nasdaq: ZOOX - message board),
Procom Technology Inc. (Nasdaq: PRCM - message board), and Nishan Systems Inc., are also jumping on the debt
wagon (see Gadzoox Cashes In, Procom Borrows $9.75M, and Nishan Secures $10M Debt Financing).
Table 1: Recent Debt Transactions
Company Amount Date announced Type of transaction
Brocade Communications Systems Inc. $500 million Dec. 18, 2001 Convertible bonds
Emulex Corp. $300 million Jan. 23, 2002 Convertible bonds
Adaptec Inc. $250 million Feb. 27, 2002 Convertible bonds
CNT $125 million Feb. 14, 2002 Convertible bonds
Nishan Systems Inc. $10 million Dec. 12, 2001 Line of credit
Procom Technology Inc. $9.75 million Jan. 8, 2002 Bank loan
Gadzoox Networks Inc. $9 million Jan. 24, 2002 Convertible bonds and stock
Total $1.2 billion
What's going on here? Analysts say there are a variety of reasons these companies are boosting their debt right
now.
For the smaller companies in this group, the need for cash is pretty easy to explain: to stay alive. "For Gadzoox,
Procom, and Nishan, it is simply a matter of trying to keep the doors open," says James Poyner, analyst with CE
Unterberg Towbin.
It's less clear why the others -- Brocade, Emulex, Adaptec, and CNT -- have issued bonds. Each of these
companies uses the standard boilerplate language that the money raised will be used for "general corporate
purposes," which could include acquisitions. The consensus among analysts we surveyed is that, with interest rates
very low right now, debt is a cheap way to obtain capital. Emulex's bonds have a 1.75 percent interest rate, while
Brocade's are set at 2 percent, CNT's at 3 (Adaptec's bond rate was not available at press time).
In fact, "in the case of Brocade and Emulex, the terms were so favorable that these deals are probably accretive to
EPS," says Steve Berg of Punk Ziegel & Co. In other words, Berg says, those companies can invest the money at a
higher rate than they are paying, which causes positive net interest income to fall to the bottom line.
A broader reading of the tea leaves, however, is that these debt offerings are an indication of impending
consolidation in the industry.
"With so much cash burning a hole in so many balance sheets, I would think the industry might be in for some
consolidation," says Mark Kelleher, an analyst with First Albany Corp. "Brocade, Emulex, and Adaptec alone have
over $2 billion in cash."
Berg agrees that the multiple debt offerings indicate acquisitions may be in the offing. "In the case of the gorillas like
Brocade and Emulex, they need the excess funds to stay big and liquid, so they can be considered a serious buyer
and avoid being acquired themselves."
However, Dan Renouard, senior research analyst at Robert W. Baird & Co. Inc., believes there's no especially
sound rationale behind the borrowing spree.
"While interest rates are fairly low, the management teams embarking on these offerings are clearly signaling that
the potential upside on the stock is somewhat limited -- or else they would wait," he says, adding, "People tend to
spend what they have and tend to spend other people's money even more foolishly than their own."
We'll see soon enough whether these companies are simply raising cash for a rainy day, or if they have something
else in mind.
— Todd Spangler, Senior Editor, Byte and Switch
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