Brocade to Raise $500M in Bond Offering

Brocade Communications Systems Inc. (Nasdaq: BRCD) announced Tuesday that it intends to raise $500 million by selling a convertible bond to institutional investors, due to be paid 2007 (see Brocade to Offer $500M in Notes).

The interest rate, conversion rate, and offering price must still be set. The offer is due to close this month, and Brocade will grant the initial purchasers a 30-day option to buy an additional $50 million worth of notes. Analysts say the interest rate on the bond will probably be fairly low, between 1.75 and 2.25 percent.

The debt offering was seen as a red flag by Wall Street, where initial reaction to the news prompted a sell-off of Brocades stock. The share price dropped 4.05 percent to $33.61 by midday on the Nasdaq.

Brocade said in a statement that it will use the proceeds for general corporate purposes, including working capital and capital expenditures.

Under closer scrutiny however, it would seem that Brocade has more up its sleeve for this cash than just working capital.”They have over $250 million in cash versus almost no debt and are free cash-flow positive, so working capital and capex are not valid reasons,” says Dan Renouard, vice president of research at Robert W. Baird & Co. Inc.

”The only logical thing we can conclude is that an acquisitionis either in the works or soon to be in the works -- that may have to includecash as a component,” Renouard asserts.

So what does Brocade need? [Ed note: apart from a sense of humor! -- see Greg Reyes, Chairman and CEO, Brocade and Brocade CEO in Tick-Top Form.]

”If [Brocade] is looking toward an acquisition, it has no iSCSI or InfiniBand products yet, which are significant holes in the portfolio,” says Harsh Kumar, storage analyst at Morgan Keegan & Company Inc.

Other analysts say that incurring debt to make an acquisition is very risky, and Brocade is more likely to use its stock to buy companies, given its high valuation.That the company is not apparently doing so seems significant to some sources. “[The bond offering is] more of a defensive move,” says one Wall Street analyst who declined to be named. “Brocade might be looking at operating losses, and this puts cash on its balance sheet.”

There are signs that Brocade insiders are less than bullish on the future of the company's stock. According to SEC filings this month, Brocade CEO Greg Reyes plans to sell 250,000 shares for $9.2 million. He has filed to sell $100 million in stock over the last year. VP of strategy Paul Bonderson is selling 50,000 shares for $1.9 million, and the new CFO, Antonio Canova, plans to sell 30,000 shares for $1.1 million.

— Jo Maitland, Senior Editor, Byte and Switch
http://www.byteandswitch.com