Brocade's Costly Victory

3:50 PM -- Investors today are wondering why, after winning its war with McData, Brocade spent $713 million to sign a peace treaty. (See Brocade Bags McData For $713M.)

The price tag appears steep, unless Cisco was ready to pounce on McData or McData was poised for a rebound. But neither seems to be the case. Brocade CEO Mike Klayko admitted there were no other bidders to drive up the price for its rival. And there's no sign of a McData rebound -- especially after it disclosed today that it had yet another disappointing quarter.

According to CEO John Kelley, 2005 was supposed to be McData's big year. That's when it finally got around to shipping products -- including its flagship i10K director -- from 2003 acquisitions of Nishan Systems and Sanera Systems. But McData was late with 4-Gibt/s gear and certification of its i10K from EMC was held up due to a series of problems. McData struggled throughout 2005, and things turned worse in 2006. (See McData Takes a Direct Hit and McData Trails Switch Rivals.)

According to market research firm Dell'Oro Group, McData's director share shrunk from 86 percent in 2001 to 36 percent in the first quarter of this year.

"McData was in what looked like an unstoppable downward spiral," says a technology analyst who asked not to be named. "They were losing market share rapidly in the director market to Cisco and were lacking strategic vision. They were late on their 4-gig transition and still do not have it in the i10K. So they were no threat to either Brocade or Cisco. I think Brocade paid too much."Investors agree. Brocade shares were down 17.92 percent or $1.10 to $5.04 by late afternoon.

"McData is shrinking and would have continued to shrink," says a buy-side Wall Street analyst who invests in Brocade. "Brocade is just buying McData for the customer base. But Brocade would have gotten about 70 percent of those customers anyway within a year."

Of course, Brocade will still have to battle Cisco for those customers. Cisco's strength is in the director space, and its entry into storage a few years back was a key contributor to McData's demise. Considering integration after acquisitions usually take longer and prove more of a distraction than originally planned, Cisco is in a good position to grab more customers.

To a lesser degree, QLogic also stands to benefit. QLogic loses its blade switch partner McData, but becomes the most viable alternative to Brocade in the lower-end switch market. (See McData Hops on QLogic Blades.) The end of McData could open up OEM deals with major storage vendors for QLogic.

Who loses? QLogic's HBA rival Emulex could find itself dropping deals to customers who like the idea of getting HBAs and switches from the same vendor. And WAFS vendor Riverbed's OEM deal with McData is in jeopardy because Brocade has a similar partnership with Packeteer. (See McData Hits Remote Control.) Riverbed, which has filed to go public, was counting on revenue from the switch vendor to accelerate its growth.Dave Raffo, News Editor, Byte and Switch