Reversals of Fortune

What a difference a year makes. Early last year McData Corp. (Nasdaq: MCDTA) was zooming downhill faster than an inebriated wombat on skis.

It was late to market with 2-Gbit/s Fibre Channel. Its sales were stalling. And it was forced to issue two earnings warnings for the first quarter (on March 5 and April 4, 2002). Because of an inventory writeoff, McData posted a gross margin of 21.5 percent for the quarter a truly gross gross margin (see McData Lowers Guidance and McData Meets Lower Expectations).

It seemed clear McData was getting desperate when it sued archrival Brocade Communications Systems Inc. (Nasdaq: BRCD), alleging patent infringement; the case remains in arbitration (see McData Fires Lawsuit at Brocade and Smart or Desperate?).

Fast-forward 12 months: McData is in full bloom. It's profitable! Analysts credit its low-cost Sphereon 4500 with successfully chewing into Brocade's dominant position in FC fabric switches. And while it's not certain yet whether McData is in full turnaround or whether it's just had a few good quarters, clearly, things have been clicking for the kids in Broomfield (see McData Switches on McProfit).

McData's convalescence is even more dramatic when you consider what's happened to Brocade over the same time period. True, Brocade still holds the overall lead in the Fibre Channel marketplace. But it has suffered serious wounds, some of them self-inflicted. It has laid off 275 employees, nearly 20 percent of its work force. CEO Greg Reyes effectively purged half his senior management team late last year. And in the most recent quarter, Brocade was nailed with a sizeable loss because of a $135 million charge related to its acquisition of Rhapsody Networks (see Brocade Hit With Q2 Loss, Brocade Chops More Heads, and Brocade Cleans House).And in the ultimate backhanded compliment, Cisco Systems Inc. (Nasdaq: CSCO) now appears to have shifted its strategy to attack, first and foremost, McData – not Brocade.

"It is no secret that Cisco/Andiamo tailored its business model to go after Brocade, with almost all major aspects of its strategy mirroring the best parts of Brocade's business model," writes Goldman Sachs & Co. analyst Laura Conigliaro in a research note issued this week. "But over the course of 2002, the market reality began to shift, with McData recovering on its own and then at least partially taking advantage of the damage Cisco's marketing had done to Brocade (and the damage Brocade had done to itself) starting in the fall of 2002."

Continues Conigliaro: "In 2003, McData has clearly surged ahead with its new products in both the high-end and midrange, and thus it is only natural that Cisco would now be shifting its strategy to go after the strongest player."

However, a Cisco insider says this is a misreading of the company's strategy. "The target was always McData – Brocade just got in the way," he says.

In any case, the nitty-gritty financial details of the McData/Brocade saga are included in Byte and Switch Insider's inaugural report – The Top 10 Public Storage Networking Companies – which ranks the industry's biggest players based on quantitative financial data.Needless to say, McData ends up with a much higher ranking than Brocade, which lands (whumpppppp!) at the No. 10 spot on the list.

Fortune, comrades, is a fickle mistress.

Meanwhile, for the storage industry at large, the Byte and Switch Insider report reveals some generally positive signs. For example, every company with the exception of Brocade had sequential revenue growth in Q4 2002. That said, six of them had sequential revenue declines in Q1 2003, and, even though some of this must be attributed to seasonal spending factors, it shows IT spending has not fully bounced back.

QLogic ends up with the best overall rating, although it also has the highest relative valuation of any of its peers with a price-to-sales ratio 40 percent higher than the next closest company (see QLogic Tops B&S Insider Ranking).

Note that we considered only companies that derive all or nearly all of their revenues from storage hardware, software, or services, which means we exclude big storage players, including Hewlett-Packard Co. (NYSE: HPQ) and IBM Corp. (NYSE: IBM). The companies included in this report, which we selected based on size of market capitalization, are:

But getting back to our original soap opera: Will McData continue its winning streak? Can Brocade right the ship? Cisco's aggressive entry into the SAN switch market is certain to cause some unpredictable turbulence over the next year (see IBM Slashes Cisco MDS Pricing). We'll see where things stand a year from now.

— Todd Spangler, US Editor, Byte and Switch

For more information or to purchase this month's report – The Top 10 Public Storage Networking Companies – please visit: Byte and Switch Insider