Emulex & ServerEngines: A New Beginning or Armageddon?

Emulex may have surprised a few people with their purchase of ServerEngines; however, many in the industry knew for some time that the company was sorely lacking control of their own destiny with regard to their struggling FCoE offering. Those keeping track of the players in the FCoE space have watched Emulex run around for nearly two years promoting the heck out of privately held ServerEngines, and ultimately it appears as though Emulex will have to cough up an absurd pile of money to finally buy the company--a staggering $225M.

This amount represents nearly 1/3rd of Emulex's valuation and half their enterprise value. For $225M, Emulex gets 170 employees, a couple of 10GbE NIC designs, LAN On Motherboard chips (LOMs), and about $4M in incremental revenue per quarter. If Emulex thinks that ServerEngines has such compelling technology, then why didn't they just buy the company when they first performed due diligence on the core Ethernet technology they planned to use as the basis for their "UCNA?"  Why spend tens of millions of dollars promoting the technology and pump up the valuation of a company that nobody ever heard of prior to their public endorsement of ServerEngines' products?  

I understand how some can view this acquisition as a wedding of two connectivity technology vendors, but this wedding is sure costing a lot of money, and Emulex is on a spending spree. To say Emulex's spending is getting out of control may be understatement. For example, the company recently paid for the band Smash Mouth to perform for channel partners in Las Vegas. Next week, Emulex is renting out the House of Blues in Las Vegas for a party it's throwing for more channel partners - and giving away a $20,000 Harley Davidson motorcycle as well!  

I haven't seen spending like this since the dot com companies spent bundles of cash with no real revenue recognition to support the spending. Sadly, we all viewed the collapse of the dot com segment in what was a stunning debacle. Okay, I understand that vendors need to spend on promotional activity and marketing events, and Emulex is recognizing revenue, but this is 2010, and Emulex is busy spending like it's 1999.

Does Emulex really think that a sales person having a free beer and listening to Smash Mouth is going to sell more Emulex adapters?  Who's running the show at Emulex these days? I speak to a lot of vendors every week, and "austerity" is the watchword these days - keep it simple and keep the investors or shareholders confident that spending is down and revenue is growing.  Spending nearly a quarter-of-a-billion dollars on an acquisition that should have been made long ago at a much lower purchase price, and arguably frivolous spending that mirrors expenditures of companies that have gone out with a bang, leaves one to wonder about the company's strategy.At this rate of spending, Analytico believes that Emulex may be in the unintentional process of creating its own unique financial Armageddon. In our opinion, the company may be creating an environment that will eventually lead to an internal collapse of its core operating model and the company very well could begin to implode from within.

Let's call it like it is:  the acquisition of ServerEngines is not a marriage. It's the equivalent of a complete and utter abandonment of cash into the black hole of time that may come back to cripple Emulex's business model.  It is still my opinion that shareholders should have taken the comparatively rich Broadcom offer.  It is clear that Emulex has failed to increase its valuation since that once lucrative offer expired one year ago.

Can the acquisition of ServerEngines be a new beginning for Emulex? I believe it could very well have been a new beginning for the company if they would have executed on the acquisition long ago. Dark times very well may be ahead for Emulex and their "UCNAs," given the jump that Brocade and QLogic have on them with the development, release and design wins under their respective belts at this time. While its competitors will be focused on executing even faster in the converged networking space in 2010, Emulex will be tied up with product, IT and personnel integration issues. Which leads me to wonder if Emulex will put its own lineup of ASICs on the deceased list now that it owns the ServerEngines ASICs?

At a time when companies should be hoarding cash and strengthening their balance sheets, Emulex is starting to bloat with more and more employees and considerably less cash then it had just two weeks ago. Emulex's CEO Jim McCluney was recently quoted as saying, "ServerEngines gave Emulex a fast path to combining Ethernet with its own Fibre Channel stack, and now that the UCNAs are coming to market it makes sense to bring the technology in-house. That gives Emulex more control of the technology."  The problem here is that the technology should have been brought in-house long ago, and now the competition has leapfrogged out ahead of Emulex.  

Given the competitive state of the FCoE market overall, it's hard to see how this translates into a new beginning for Emulex.  Let's take another look at this acquisition a few quarters from now and access just how strategic, and smart, it was this late in the game.