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Author: TMFFuz Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 8764  
Subject: Brocade, a Foolish Analysis Date: 6/16/2000 1:07 PM
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I have been working on some of my own analysis of Brocade (BRCD) as a possible Rule Maker and/or Gorilla Game play (either as a Gorilla or a King). So, I thought I would share it with Fools on this board and open it up for comments.

One note first, however. I am still having trouble with the notion of an “open proprietary architecture.” Mick Buckley helped me out by referencing the book, so I understand the “open” part now. I guess what I am searching for is a series of two or three questions I could ask myself when doing research to nail this point. I have finished the book, but I have not written-up my own study guide yet, so I may find it then.

A series of questions would reduce my time looking at “no-go” companies.

If you are interested in information about BRCD not presented below, log on to their site at http://www.brocade.com/

Anyway…

Dominant Brand
BRCD has an estimated 80%-90% of the fibre channel switch market. The company sells primarily into the OEM market (about 75% of revenues) and many OEMs use the BRCD switch under their own names. Expect this to change however, as BRCD management is well aware of branding their product and invoking the idea of customers asking for “Brocade” switches when implementing a SAN. However, it appears that BRCD is becoming the standard in this area, and increased software development by the firm will only strengthen their position in this space. Due to the overwhelming market share, I give BRCD a Rule Maker point here.

BRCD also has relationships with major players in this market including EMC (despite their McData unit), Compaq, H-P, IBM, and Dell Computer.

Expanding Possibilities
About 35% of the Fortune 500 companies have implemented some type of storage area network (albeit homogenous) with another 80% looking pretty closely. Has it crossed the chasm yet? I don't know, but there is no doubt in my mind that SANs will be implemented in 95%+ of the largest corporations. And, they will use multiple SANs. In addition, demand will grow rapidly once standards are adopted for heterogeneous environments.

In addition to fibre channel switches, BRCD can also pursue strategies in the higher-end sections of the market, or be a key player in some type of Ethernet convergence. A lot of people have an Ethernet vs. fibre channel mentality now, but it seems to me at this point that fibre channel is going to be used in the SANs because of performance features and larger data transfers in the network (despite that notion of Ethernet becoming faster than fibre channel over the next couple of years).

As a first-mover, BRCD has shown an innovative nature. This bodes well for other possibilities in the storage space. 1point.

Repeat purchase business
Firms will implement multiple storage networks (loops hold 126 spots) and switches will connect island of SANs for one-to-one connectivity. As the price of storage comes down, demand will rise by a greater percentage (a 1% decline in storage pricing = 4% increase in storage demand). Repeat purchase business? I think so. 1point.

Convenience
In my opinion, data is the most valuable asset of any company in the Net economy. Data about customers to attract, retain, and leverage relationships with them as well as data about competitors, and data used to build strategic partnerships, all create competitive advantage. This data needs to be available to anyone, anytime, for it is mission-critical. Storage is key to any firm competing today. And, BRCD offers a very important component of the network. Convenience? Try necessity on for size! 1point.

Interest and familiarity
I'm interested which is why I am writing this. If you have read this far, you are interested too. 1 point.

How are we doing so far? 5 points. Now for the quantitative stuff that does not lie : )

Sales growth of 10% year-over year
Hold on to your seats Fool! Revenues of $62.053 million represent a 489% growth rate over the same period last year. This is a comfortable buffer over our 10% bogey : ) 1 point.

Gross margins of at least 50%
Gross margin was 58% and expanding from 48.4% during the same period last year. More importantly, BRCD has competitive advantages in the OS side of fibre channel switching. Software, not hardware is often the exciting story in storage (see EMC). Currently, software presents a small portion of BRCD's sales (3%-4%) but should become an increasing contribution to their top line. This means expanding gross margins are possible. Or, at the very least, they may hold here. 1point.

Net margins at least 7%
Net income of $13.316 million led to a net margin of 21.5%. 1point.

Cash no less than 1.5x total debt
No long-term debt. And, while we are here, the balance sheet looks pretty clean at first blush. 1 point. Let's look at the Flow.

Flow ratio below 1.25
Current assets = $152,098 million
Cash and equivalents = $111,529 million
Current liabilities = $59,246 million
No current portion of long-term debt

Hence, the Flow ratio is 0.685 which indicates to Fools that the company is pretty effective in managing working capital accounts and creating sources of rather than uses of cash.

Cash King Margin
Cash from operation = $$36,796 million
Capital expenditures = $8,139 million
Sales = $62,059 million

CKM = 46.18% which exceeds the bogey. I point.

Conclusion
First, I do not own shares of BRCD and I won't for at least the next five days (Fool policy). In assessing the company, I would want to look a little more closely at competitors like Ancor, make sure my conclusions about Ethernet make sense to me, and check the threshold margin. I know intuitively that BRCD exceeds the threshold margin, but it helps to see how scalable the business model is and what it can become (by forecasting the threshold margin).

Anyway, that is my run down.

Have a nice weekend,

TMFFuz (a.k.a. John)
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