Emulex Jilts SAN Valley

Less than two weeks ago, executives at SAN Valley Systems Inc., a maker of Fibre Channel over IP gateways, were breathing sighs of relief as Emulex Corp. (NYSE: ELX) signed a letter of intent to acquire the company.

But regrettably for the struggling startup, the deal was scuttled at the last minute when Emulex got a nasty case of the jitters. The expression the deal isn't done until it's done -- or as Wall Street likes to say, another "DFT" (deal fell through) -- is pretty well-worn these days, given the unstable market conditions.

In Emulex's case, its stock was at around $25 a share two weeks ago, but it's down to $19 today. "Market psychology matters," says a financial analyst familiar with both companies, who requested anonymity. "In better times, Wall Street would see this acquisition as an expansion of Emulexs addressable market, on the cheap; but in a nervous market it’s seen as a sign of desperation."

The weekend before the deal was due to close, Emulex executives rang the SAN Valley crew and called the deal off. The financial details of the acquisition were unavailable. Officials at Emulex and SAN Valley declined to comment on the record.

An insider at SAN Valley told us this kind of thing happens all the time. "A letter of intent is non-binding," the source says. "There is more due diligence after this, then a definitive agreement, then closing."It’s a cautionary tale for other startups in the same boat: Don’t crack open the champagne too soon! Our source at SAN Valley adds, "We are still trying to find a home and have two letters of intent on the table." [Ed. note: For whatever they're worth!] He declined to name the other interested parties.

There's one other plausible reason for Emulex's last-minute change of heart, aside from fearing a negative market reaction. Sources familiar with the deal say Emulex was keen to get its hands on SAN Valley’s reseller deal with Hewlett-Packard Co. (NYSE: HPQ). "This channel is important to a number of vendors," notes our SAN Valley source (see SAN Valley Works With Compaq).

Recently Emulex has been losing bids with HP to its rival, QLogic Corp. (Nasdaq: QLGC) – a situation Emulex hopes to turn around (see HP Puts QLogic in Blade Server).

But when HP signed an OEM deal with Brocade Communications Systems Inc. (Nasdaq: BRCD) for the Rhapsody technology last month, observers say it pulled the rug out from under the SAN Valley deal, as Emulex raised questions about the validity of the startup's connection with the server vendor (see HP OEMs Brocade/Rhapsody Switch).

SAN Valley sources declined to comment on this piece of the story. It’s surely a tough one to swallow as the acquisition represented a lifeline for SAN Valley, which is rapidly running out of cash (see SAN Startups on the Block)."It’s just taking longer to get to breakeven than anyone could have foreseen in 2000," our insider says. To recap, SAN Valley has received a total of about $40 million in funding since April 1999 from Agilent Technologies Inc. (NYSE: A), Cisco Systems Inc. (Nasdaq: CSCO), Innovacom Venture Capital, Moore Capital Management Inc., Upstart Capital, and Vertex Management Inc.

However, SAN Valley, which has 25 employees, doubled its revenues in December, pulling in $600,000. Sales for January are apparently tracking nicely, the company says. In addition, SAN Valley plans to launch its Fibre Channel router, which it claims has been demonstrated in a number of complex networks, late this summer.

Like SANcastle Technologies Inc.'s product, SAN Valley's router will connect islands of SANs running incompatible Fibre Channel switches from different vendors. SAN Valley claims its router is technically superior to anything else on the market, but we'll just wait and see about that when it eventually delivers (see SANcastle Retreats to FC Kingdom