Cisco Moves In on Gadzoox

Cisco Systems Inc. (Nasdaq: CSCO) took another cautious step into the storage networking world this week, when two of its senior executives joined the board of Fibre Channel switch vendor Gadzoox Networks Inc. (Nasdaq: ZOOX).

On the surface, this seems like a fairly innocuous announcement. However, Cisco recently vowed to dominate this sector within the next two to three years (see All Eyes on Cisco). That may explain why the appointment of Steven M. West (a member of Cisco's board of directors) and Sylvia Summers (group VP of Cisco's service provider business unit) to the Gadzoox board promptly set off rumors on Wall Street of a possible acquisition bid.

"Gadzoox must have something Cisco is interested in," says William Hurley, storage analyst with the The Yankee Group. "The world is awash with Cisco board members, but this is a clear sign the company is throwing more weight around in this space to gain influence."

Simon Weeden, M&A specialist at Goldman Sachs & Co., is less certain: "Putting people on the board is an unlikely route to an acquisition, as it is a rather public statement of interest, although this doesn't mean that an acquisition might not happen later."

Cisco refused to comment on the acquisition speculation. However, Mike Volpi, Cisco's chief strategy officer, has said that he is looking for companies with a mature development cycle. "We can afford these now because of the low valuation of the stock market," he recently told a

Gartner Groupnetworking conference.Clearly, Volpi wants tried and tested technology. Gadzoox has that. However, its market share numbers aren't stellar. IDC pitches the company at number four in the FC SAN market behind Brocade Communications Systems Inc. (Nasdaq: BRCD), McData Corp. (Nasdaq: MCDT),and QLogic Corp. (Nasdaq: QLGC).

Further, Gadzoox's financials over the last couple of quarters have not been anything to write home about, and it expects revenues to remain flat for the next two. On March 31, Gadzoox reported a fourth-quarter 2001 net loss of $40.3 million on revenues of $6.4 million, compared with a net loss of $10.3 million on revenues of $47.9 million for the same period a year ago.

In other words, if Cisco does buy Gadzoox, it won't be in the hopes of reaping big revenues from the deal in the immediate future.

So why would Cisco be interested? For Gadzoox's technology, probably.

Gadzoox's newly released Slingshot 4218 is a 2-Gbit/s Fibre Channel switch, available ahead of Brocade's 2-gig product, which is slated to ship year end. Another possible strength of the switch is that it can also be connected to gigabit Ethernet networks -- meaning it could plug straight into Cisco's Catalyst LAN switches to connect storage devices over wide-area networks.Gadzoox's "willingness to be experimental with gigabit Ethernet has put them in a strong position," says Hurley.

The company has said that it expects the OEM adoption of Slingshot, it's new 2-Gbit/s Fibre Channel switch, to drive revenue in the third and fourth quarters of fiscal 2002 by 40 to 70 percent, quarter over quarter.

Cisco may have noticed another feather in Gadzoox's cap. Gadzoox has played a major part in the development of the FCIP (Fibre Channel over IP) standard, expected to be approved by the standards bodies in September. Gadzoox wrote this protocol with help from Lucent Technologies Inc. (NYSE: LU).

It enables the encapsulation of Fibre Channel within IP packets to transport storage traffic over long distances. FCIP could thus play a significant part in the overall IP storage market that Cisco wants to dominate.

To get in on this action Cisco bought Nuspeed Internet Systems for $450 million last year for its iSCSI (Internet over SCSI) device and expertise in this protocol, which also transports storage traffic over wide-area networks. According to the analysts however, iSCSI can't match FCIP in some areas. "It doesn't provide the performance factors of native Fibre Channel that FCIP will," says Hurley.

"It seems Cisco is hedging its bets on the standards front. Rather than taking its usual 'IP will rule' approach, it can see Fibre Channel is where the money is right now," says Hurley. On whether Cisco might actually put its hand in its pocket and buy Gadzoox he is less convinced. "Gadzoox is a diminishing stock in the Fibre Channel galaxy, so Cisco would be buying them cheap, but I'd be surprised."All this is particularly interesting in light of Cisco's partnership with Brocade. That partnership is supposed to produce products for this space. Brocade declined to comment on this story.

"The move is clearly a snub to Brocade," says Hurley, "and the partnership between Cisco and Brocade is already on the rocks." The two firms are supposed to be jointly working on an FC blade for Cisco's Catalyst 6000 family, but neither company has been very open about how this development work is going (see All Eyes on Cisco).

At 2.30 pm EST on Wednesday, Gadzoox stock was down 0.34 percent at 2.97 a share, while Cisco was down 0.64 percent at 17.9 a share, compared with the previous day of trading. The stock climbed all the way to 3.50 earlier this week.

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