OFF AND RUNNING
McDATA Corp.'s glossy debut on stock market no overnight success
By Kris Hudson, Denver Rocky Mountain News Staff Writer
You could say that the value of McData Corp. chief executive officer John "Jack" McDonnell's stock rocketed to nearly $900 million in one day when his company went public last month, and you'd be correct.
You could say that McData Corp.'s $2.4 billion market value now eclipses the $1.6 billion market value of predecessor Storage Technology Corp., the data-storage matriarch McDonnell left to start McData. You'd be right again.
The only flaw in that thinking is the supposition that it all happened overnight.
Wall Street embraced McData on Aug. 9 as it has few other companies this year, lifting McData's stock 205 percent on its first day of trading and dumping $350 million into the Broomfield company's coffers. But the foundation for what occurred that day was built over McData's 18-year history, a rocky stretch that sometimes found McData atop its industry but also saw the company strain to meet its payroll at times.
"We exceeded the expectations in terms of the market value, but that wasn't our big focus," McDonnell said last week. "The important thing was that we're moving into an area where we're getting our name in front of people and they'll start recognizing the brand as the best in the industry. And we can start attracting more people as a public company.
"I was surprised by how well it was received, but I think it's a function of the fact that we have a good reputation for executing extremely well in every market we've competed in," he said. "And, two, it's a very exciting market space right now."
Industry analysts and IPO observers credit several factors for the success of McData's stock-market debut. First, the company has a long history in its industry and has logged a dramatic rise in revenue over the past three years. Second, McData's industry — networking equipment that connects data storage machines — is among the hottest on Wall Street these days, thanks to the rise of the data-intensive Internet Economy.
"They've got decent revenue, some legacy business and a lot of experience," said John McArthur, vice president of storage research for market research firm IDC. "So if you combine the growing need for high availability (of data in systems), the massive amount of storage that is being deployed and the keen interest in networking that storage, McData kind of sits in the middle of all that."
The stock market is well aware of McData's position. Every one of the 74 institutional investors McDonnell and chief financial officer Dee Perry visited in a whirlwind 21/2-week road show decided to participate in McData's IPO. When the stock debuted Aug. 9, McData priced the 14.4 million shares it offered at $28, but trading opened at a nosebleed-inducing $76 and quickly climbed to $90.88 before closing the day at $85.56.
In the month since the offering, McData's stock has soared as high as $110. Last week, the slumping Nasdaq stock market pulled the stock back down, depositing it at $88 at the market's close Friday.
McData's underwriters aren't the only ones smiling. Each of the company's 500 employees owns stock. McDonnell's 10.5 million shares are now worth $924 million. Perry's 400,000 shares are worth $35.2 million, as are vice president Richard Carlson's 400,000 shares.
Even so, don't expect to see droves of McData employees leaving to sail the Caribbean for the rest of their lives.
"For us at McData, we know that all of that is on paper unless we execute," said Perry, a McData employee for the past 10 years. "Certainly, people will look at the stock, but everyone in the world looks at their stock. I think that most people here recognize that for us to realize the value we have on paper, we have to execute."
Rarely has McData had a chance to coast. McDonnell founded the company with five former StorageTek colleagues in 1982. Recruited to StorageTek two years earlier to launch the company's data-networking division, McDonnell left after it became apparent the financially faltering company would not fund his project.
McDonnell revived the data-networking project as McData. In another decision that would prove wise years later, he moved the new company across U.S. 36 from StorageTek to become the first tenant in the now-booming Interlocken business park.
In its early years, McData sold cluster networking equipment that competed with IBM products. However, that market began to fade in the early 1990s, and McData lived hand-to-mouth until it found its next big thing.
In 1994, McData gained a contract to sell equipment to IBM Corp. that connected IBM's mainframe computers to other devices in computer systems. McData designed the specialized equipment to work with IBM's Escon technology format, which led to IBM becoming McData's largest, and nearly its only customer.
Even in 1994, McDonnell aspired to make McData a publicly traded company. Yet he knew the public markets would not favor McData with one customer accounting for nearly all the company's revenue. Wall Street would consider it too risky. Thus, McDonnell took a different route to expand McData: He sold it to disk-storage giant EMC Corp. in 1995 for $234 million in stock.
In EMC, McData found a parent company and customer with a voracious appetite for McData's products. With the popularity of EMC's disk-storage systems exploding, the company had a keen interest in McData's switches. The switches — often called directors when they're souped up enough to handle massive data loads in big, "enterprise-class" systems — are used to route data in complex, interconnected storage systems.
What's more, a new data storage format called storage area networks, or SANs, emerged in 1998 as an increasingly preferred method of large-scale storage. A SAN is an interconnected pool of storage devices that allows for easier management of the system and more efficient use of available storage capacity. A key part of a SAN is the switch or director used to route data through it.
Buoyed by its association with EMC and its role in the SAN market, McData saw its revenue rise from $36.5 million in 1998 to $95.7 million in 1999 to $103.6 million in the first six months of this year. Some analysts describe McData as the Cisco Systems of its market.
"McData has kind of positioned itself as a Cisco, a supplier to the core enterprise structure," said Robert Gray, a storage-systems research director at IDC. "These products command better margins. They're higher-ticket items. They're tougher to make. If you're buying them, you want to buy them from an organization whose brand name you can trust, because you're going to have them as the backbone of your storage pool."
If McData can remain a "Cisco," it stands to claim a large chunk of a growing market. IDC predicts the market for switches and hubs in storage networks will grow from $437 million in 1999 to more than $4.1 billion in 2003. The fastest growing segment of that market, IDC says, will be the director-class niche that McData occupies.
Even so, McData has found in recent years that its status as a subsidiary of EMC hampered its efforts to sell its equipment to EMC's competitors — IBM, Sun Microsystems, Compaq Computer and Hewlett-Packard Co. Thus, McDonnell's long-held hopes of taking McData public began to carry more weight.
"We did it because, in the market we compete in, to be the most successful requires that we do business with EMC's competitors," McDonnell said. "We're kind of operating as a Switzerland here amid all these big companies. We have to stand as an independent so that we can deal with all of the server vendors and the storage vendors without any particular bias."
In its IPO, McData issued nearly 14.4 million new shares. The company's management already owns 11.8 million shares, and EMC owns 81 million shares. EMC intends to disperse its McData shares to EMC shareholders within the next six to 12 months, thereby making McData an independent company.
McData intends to use its IPO proceeds for general corporate purposes. A portion of the windfall likely will support the company's plans to build a $75 million, 500,000-square-foot headquarters campus in nearby Westmoor Technology Park of Westminster. The company foresees its 500-member staff expanding to 850 by the end of next year.
At this point, analysts say one of the few things capable of cramping McData's style is the possibility that networking giants Cisco, Nortel Networks, Lucent Technologies or all three might decide to enter the storage networking market. And McDonnell is keeping his eyes open for another potential stumbling block: complacency.
"We spent an entire afternoon celebrating (the IPO),"McDonnell said. "I told everybody at the time, 'This is great. It's a tremendous tribute to our success. But it's just a first step in the path of being a successful public company.' If anything, being under the eye of the public puts more pressure on us to perform going forward.
"I'm confident we have the people who can do that. It's satisfying to know that you're regarded in the public market as being the best."
Contact Kris Hudson at (303) 892-5155 or hudsonk@RockyMountainNews.com.
Reprinted from the September 11, 2000 edition of the Rocky Mountain News, Business Section. Copyright 2000 by Rocky Mountain News.
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