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Technology Stocks : EMC How high can it go? -- Ignore unavailable to you. Want to Upgrade?

To: Chris Carlson who wrote (10629)	7/17/2000 3:58:02 PM
From: Gus	Read Replies (2) \| Respond to of 17183

"....but will MCDT's value be discounted from EMC by the street?" EMC acquired Mcdata in late 1995. At that time Mcdata had annual sales of about $200 million. In 1997 it reorganized Mcdata into Class A, wholly owned by EMC via Mcdata Holdings, and Class B, 85% owned by Mcdata Holdings as a result of a $10 million capital infusion by Mcdata shareholders led by John McDonnell, who currently owns 5% of Class B. The premise for the reorg was to allow Mcdata to accelerate the development of FC-related products. As a result of the 1997 reorg, EMC and Mcdata agreed on the following ways to recognize Mcdata revenues: 1) ESCON - EMC keeps all ESCON revenues, but Mcdata designs and manufactures (outsourced to SCI) all ESCON Director switches. Mcdata gets paid a "fee" which I assume is their normal operating margin. 2) FICON/FC Director Switches - Mcdata develops and keeps all FICON/FC Director Switch/FabricReady software/hardware revenues. As a result of this revenue recognition policy, Mcdata's financial statements were restated from the beginning of Mcdata's 1995 fiscal year as follows: Restated Revenues 1995 - $34.3m 1996 - $32.2m 1997 - $33.0m 1998 - $36.5m 1999 - $95.3m 2000 - $47.1m (March quarter) Because EMC owns over 50% of Mcdata, it still recognizes a prorated portion of Mcdata's overall revenues on its books. Still, the amounts involved are not substantial for a $6.7 billion company on its way to $12 billion by 2001. The growth rate, however, is another thing altogether. Mcdata started selling its flagship ED5000 Director switches in 1998 and clearly sales are just starting to pick up. The ED5000, for example, only accounted for 43% of 1999 sales and figure to rapidly increase during the post-Y2K corporate upgrade cycle now underway as reflected by the $47.1m March quarter, which not coincidentally, saw IBM and Hitachi both agree to resell Mcdata's FC switched fabric products under the Mcdata brand. As you probably know, EMC (48%), IBM (21%) and Hitachi (26%) control about 95% of the mainframe storage market, which consists of the most complex computing environments around and which are also the natural early adopters for FC switched fabrics especially with the FICON bridge technology jointly developed by IBM and Mcdata. In terms of raw storage, the mainframe storage market is expected to go from 12.1 Petabytes this year to 145 Petabytes in 2004. 1 Petabyte = 1,000 Terabytes; 1 Terabyte = 1,000 Gigabytes. The magnitude of the storage management, protection and distribution issues implied by that kind of growth practically precludes anything but redundant directors from being used in those mission-critical switched fabrics. The key Mcdata advantage is that they are a proven supplier and deeply entrenched in the data centers as a result of having been the exclusive ESCON and FICON supplier to IBM for the last 6 years with a presence in at least 6,000 ESCON sites - versus only 400+ sites currently penetrated by its ED5000 FC directors - that traditionally have been willing to pay large premiums for seamless interoperability. With IBM readying the G7 S390 for release later this year under a new pricing scheme, the mainframe still figures to be the at the core of the largest switched fabrics that will be rolled out over the next few years. Mcdata's business will probably resemble EMC's business in that about 80% of its business will come from existing customers expanding their switched fabrics with additional directors, while about 20% will come from new customers. If the $47.1 million March quarter is a precursor to the triple digit growth in the director switch business predicted over the next few years, EMC may yet decide to keep Mcdata for a little while longer instead of spinning it out completely. Gross margins are typical for a fabless operation -- in the 48% to 75% range. Also, remember, each MCDT Class A share has 10x the voting power of MCDT Class B.