McData Picks Brocade's Pocket

The continuing momentum of McData Corp. (Nasdaq: MCDTA) in the Fibre Channel fabric switch space could result in Brocade Communications Systems Inc. (Nasdaq: BRCD) losing an incremental $32 million in revenue -- or more -- over the next year, according to analyst firm Thomas Weisel Partners.

Thomas Weisel analyst Jason Ader today simultaneously upgraded McData to Outperform (from Peer Perform) and downgraded Brocade to Underperform (also from Peer Perform) based on evidence that McData's Sphereon 4500 fabric switch is rapidly gaining share in the fabric switch space, an area that has historically been Brocade's stronghold.

"McData's push into the midrange is succeeding beyond most expectations, driven by the strength of the single-ASIC, 24-port Sphereon 4500 switch," Ader wrote in a research note.

Since introducing the 4500 switch last October, McData has steadily eaten into Brocade's share in the sub-32-port SAN switch segment, in large part because of McData's lower per-port pricing. McData has also benefited from an expanded roster of OEM partners in recent months, signing deals with Storage Technology Corp. (StorageTek) (NYSE: STK) and Sun Microsystems Inc. (Nasdaq: SUNW) (see McData Lowers Boom on Brocade, StorageTek Resells McData Switch, and Sun to Resell McData Gear).

Thomas Weisel raised its fiscal year 2003 and 2004 revenue estimates for McData, while also lowering those for Brocade. The firm now puts McData's fiscal year 2003 at $445 million (up from $436 million) and its fiscal 2004 at $508 million (up from $480 million). It estimates Brocade's fiscal 2003 revenues at $524 million (down from $526 million) and fiscal 2004 revenues at $553 million (down from $581 million).In morning trading, McData's stock jumped up 8 percent, to $14.35; Brocade's was up 1 percent, to $6.14.

Brocade appears to be responding to McData's gains by lowering the price of its 16- and 32-port SilkWorm switches, Ader notes. But he says the Sphereon 4500 has a lower-cost architecture with a single ASIC able to support up to 24 ports, compared with Brocade's ASICs that support just 8 ports. "We do not believe Brocade has enough pricing room to foil McData gains," Ader writes.

On an annualized basis, Thomas Weisel estimates that McData could steal $32 million in revenue away from Brocade. In a more aggressive model, the firm puts McData's revenue gains at $52 million.

Meanwhile, Cisco Systems Inc. (Nasdaq: CSCO) -- which is now in the process of actively ramping up sales efforts with its MDS 9000 Fibre Channel switches -- poses a greater threat to Brocade than to McData, says Thomas Weisel (see IBM Slashes Cisco MDS Pricing and HP Moves Hard on Cisco).

"We expect McData's strong product momentum in the fabric switch segment and price/performance leadership to enhance its ability to compete against Cisco," Ader writes. Brocade, on the other hand, relies on HP and IBM, which together make up 55 percent of Brocade's revenues -- and the danger is that Cisco "may be able to make meaningful inroads" with both of those OEMs.Other Wall Street analysts, however, remain bullish on Brocade. Merrill Lynch & Co. Inc. analyst John Roy, who upgraded Brocade from Neutral to Buy earlier this month, says the company is well positioned against both McData and Cisco (see Brocade & Cisco: Who's Out of Order?).

"We believe Brocade will become more competitive with McData over the summer, and that Cisco is further out than expected," Roy wrote. "The update of Brocade's Fabric OS should close the gap with McData, and should put more barriers to Cisco's entry." (See Brocade Loads Code, Signs EMC.)

Todd Spangler, US Editor, Byte and Switch