Brocade, 3Com, And Cisco

Yesterday, we looked at how the Oracle–Sun deal upset the balance of the storage industry. Cisco is another game changer, and its data center plans have similarly changed the dynamics of the networking industry. HP’s $2.7 billion 3Com deal is seen as a counter move to challenge Cisco’s dominance in the networking industry. Let’s take a closer look at networking players Brocade (NASDAQ:BRCD) and 3Com (NASDAQ:COMS).

Last year, following Cisco’s announcement of its data center plans,I speculated that Brocade and HP would join hands against Cisco. As it turns out, a year later they are strong partners. In the converged network space, Cisco and Brocade are the dominant players and after Cisco severed its ties with HP, the HP-Brocade partnership grew stronger.

However, Brocade in its recent first quarter results, reported that its Ethernet business acquired from Foundry has declined by about 25% while other competitors grew about 20%. Brocade is trying to rectify its strategy – it has hired 20-plus year veteran of HP ProCurve John McHugh as its new chief marketing officer. He is looking at a go-to-market strategy that includes more involvement with non-OEM resellers.

Brocade reported Q1 revenue of $539.5 million, up 25% y-o-y and 3.5% q-o-q. Net income was $51.1 million or $0.11 per share versus a loss of $23.9 million or $0.06 per share last year and net income of $32.1 million or $0.07 per share last quarter. The company ended the quarter with cash of $501.1 million and debt of $713 million. Q4 coverage is available here.

The other main area of growth is its storage networking business, which grew 16% q-o-q. Brocade is the market leader in the $2.4 billion storage networking market with a 71% share and in the $843 million modular SAN switch market with 64% share compared to Cisco’s 35.7%. This is the reason why Brocade, I believe, is still on HP’s radar.

Based on its performance, Brocade revised its 2010 outlook. It now targets revenue growth of 8%–12% in 2010 and non-GAAP EPS between $0.54 and $0.58. Its 2009 annual revenue was $1.9 billion. The stock is currently trading around $6 with market cap of about $2.7 billion. It hit a 52-week high of $9.84 on October 9.

3Com, on the other hand, reported a strong third quarter that beat estimates. Revenue grew 6.5% to $345.9 million driven by double-digit growth in all regions except China, which declined slightly. Net income was $41.4 million, or $0.10 per share, compared with $1.9 million, or $0.00 per share last year. The company ended the quarter with cash balance of $795 million. Q1 coverage is available here.

According to IDC, HP’s ProCurve has increased its switching market share to 5.2%, while Cisco’s share declined about 2.5% in the last year to 65.9%. According to Infonetics, 3Com was the only player to grow its enterprise routing revenues last year. Cisco has recently launched a new line of edge switches that will be 15% cheaper than its older switches. This cheaper switch strategy is in response to the challenge posed by the HP–3Com deal. The deal  just received approval from the Chinese government and is in the process of closing. As the figures above show, it is having the desired effect on Cisco.

3Com is currently trading around $7.74 with market cap of about $3 billion. It hit a 52-week high of $7.75 on March 3.

What would be really interesting is that once HP finishes integrating 3Com and really gets a handle on the latter’s China cost-structure and business model, it can go after Brocade. The Brocade SAN business, if cast in the 3Com/China business model, could really give Cisco a run for its money. The move could reduce Cisco’s market share from 35.7% down to the teens in one stroke.

That would be fun, wouldn’t it?