McCrafty

With a one-two punch of savvy acquisitions, McData Corp. (Nasdaq: MCDTA) has leapfrogged to the forefront of the SAN switching marketplace.

McData's opportunistic, all-cash deals for Sanera Systems Inc. and Nishan Systems Inc. give it an injection of expertise in high-scale Fibre Channel switching and IP that will help it match or exceed – the SAN switching offerings expected out of Cisco Systems Inc. (Nasdaq: CSCO) and Brocade Communications Systems Inc. (Nasdaq: BRCD). Wall Street generally hates the deals because there's not going to be immediate payback, but McData is thinking long-term strategy here (see McData Sweeps Up Nishan, Sanera and After Buying Spree, McData McDrops).

By patiently watching and waiting [ed. note: yes, like the cunning arctic fox on the prowl], McData clearly got the best end of these deals. On the other side, the venture capital firms backing Nishan didn't see a return on their investment, as McData's purchase price for Nishan ($83 million in cash, plus assumption of $2 million in debt) was below the amount its VCs had invested (around $100 million). Sanera's VCs actually fared much better: The startup had received around $76 million to date from its backers (with a commitment of an additional $25 million), and McData paid $102 million, an amount that does not include the approximately $10 million cash on hand Sanera has.

In the end, Nishan and Sanera realized their best option was to cut their losses and join up with McData. They each bring McData key pieces of technology that it will use to expand its portfolio both upmarket as well as down:

Now, on the third leg of its next-gen product strategy, McData has invested in storage processor startup Aarohi Communications, whose chips it will use to develop an "intelligent switch platform." The story here is still a bit murky, but McData has indicated it will let its OEMs decide what applications they want to run on the switch (mimicking Brocade's posture).Earlier this year, several industry observers, including us, wondered whether McData even had a strategy in place to counter Brocade's Rhapsody Networks acquisition and Cisco's application services blade, which it's still developing with Veritas Software Corp. (Nasdaq: VRTS).

Turns out the Colorado crew was just holding out until it felt it had the right pieces in place. For now, it appears to be trailing Brocade and Cisco in terms of R&D – but given that EMC Corp. (NYSE: EMC) executive VP of software Mark Lewis doesn't believe this market will materialize until 2005 at the soonest, it's not at all late to the party.

Meanwhile, while Nishan and Sanera employees won't get a huge dotcom-style windfall, the deals save both startups from potentially gruesome fates as SAN roadkill. Nishan had been running low on funding, as was Sanera before getting a $35 million infusion just last month.

These two were facing that familiar startup challenge of trying to sell expensive point products that would become key parts of an enterprise's most critical IT infrastructure, and trying to do it with relatively tiny sales forces and with limited access to distribution channels. That's always a tough proposition for a small company, no matter how good the technology, and even more so in a tepid spending environment. Nishan was ahead of Sanera on this front, having already shipped 500 switches into the field. But a run rate of $3 million to $5 million per quarter for a 100-person company, which is what Nishan estimates it has been generating, wasn't quite going to keep it aloft.

A few weeks ago, we dropped Nishan from the Byte and Switch Top 10 Private Companies list (see Top Ten Private Companies: Summer 2003). But in light of McData's acquisition of Nishan, even though the purchase price was "below preference," I'd say we blew that call. (On the bright side, we don't have to update the Top 10 list right away.)True, the company's VCs basically grabbed at the best possible deal they thought would ever come their way. And obviously Nishan will never have its hoped-for blockbuster IPO. But given the state of the industry today, the McData buyout represents a clear success for Nishan.

So congratulations are in order for both Nishan and Sanera. They have developed what are among the best next-generation storage networking technologies in the industry (or, perhaps more to the point, they passed through McData's due diligence). They didn't flame out in massive fireballs, like other startups we could name. And they were acquired intact.

Were Nishan and Sanera lucky to be in the right place at the right time? Of course. But the bottom line is their work will live on as part of McData – which itself is now much better fortified to fight with Brocade and Cisco.

— Todd Spangler, US Editor, Byte and Switch