Brocade (BRCD) Deal Would Equal Vertical Integration for Broadcom (AVGO) - Stifel

Stifel analyst Aaron Rakers weighed in on Brocade (NASDAQ: BRCD) on reports the company is in advanced talks to sell itself with Bloomberg reporting that Broadcom (NASDAQ: AVGO) is reportedly among the interested parties involved.

Rakers commented, "A purchase by Broadcom (Avago) would be a strategic move by Broadcom to vertically integrate in an IP switching and routing market that has increasingly moved to merchant silicon. As a reminder, in mid-September Brocade announced its new SLX 9850 data center routing solutions using Broadcom’s Jericho silicon. As a reminder, Broadcom (then Avago) had acquired Emulex a provider of Fibre Channel Host Bus Adapters (FC HBAs), which would provide the combined company with an end-to-end FC strategy. Prior to the Emulex acquisition, Avago purchased LSI, which provided the company with the leadership position in FC ASICs (silicon) for both HBAs and switching. Therefore, a combination would provide vertical integration on both Ethernet / IP networking and Fibre Channel."

He added, "While we have no knowledge of potential M&A activity, we would note that prior to hiring Lloyd Carney as CEO in January 2013, talk had persisted that Brocade was looking to sell itself in a potential deal with previous suitors including Hewlett Packard, Oracle, and IBM. Since Mr. Carney joined Brocade the company has done a very good job of right-sizing its operating expense structure, but has continued to face choppy overall revenue results. Brocade’s Storage (FC Switching; ~65% of total revenue – product + services) has declined by a 2% CAGR from calendar 2012 to 2015, while Ethernet revenue has grown at a 3% CAGR or in-line with the overall market growth rate. At its recent (9/21) Analyst Day event Brocade outlined expectations that the FC Switching market would decline at a 4% to 6% CAGR going forward (up from the prior year expectation of flat to down 2%), while Ethernet / IP networking revenue would grow at 12%-15% ( including Ruckus acquisition)."

From a valuation perspective, at $11/sh. and with the current $440 million net debt position they would arrive at an implied ~$4.9 billion enterprise value, or approximately 7.3x EV/EBITDA on our current calendar 2017 estimate.

The firm maintained a Hold rating and price target of $10 on BRCD.

For an analyst ratings summary and ratings history on Brocade click here. For more ratings news on Brocade click here.

Shares of Brocade closed at $8.69 yesterday.

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