5 Deal-Ready Stocks Loved by Hedge Funds

Brocade Communications

Interestingly, as a rumored buyer of Brocade Communications (BRCD) pared its stake in the networking equipment company, competitor hedge funds rushed in buying up shares in the fourth quarter as rumors of a takeover bid swirled. The company nonetheless is a perennial takeover target after putting itself up for sale in 2009.

Elliott Management sold over 9 million Brocade shares between Nov. 3 and Jan. 12, according to filings with the SEC, even as analysts pointed to the hedge funds a possible acquirer of the company. In December, ThinkEquity analysts pointed to Elliott Management, a 10% stakeholder in Brocade, as a potential buyer. Elliott Management turned out to be Brocade's biggest share seller in the quarter.

In January, Reuters reported that Brocade Communications received a first round of bids from private equity buyers, citing unnamed sources. The news followed October, reports that the firm had hired technology investment banker Qatalyst Partners to initiate a sale process.

However, a deal offer was discounted just a day later that signaled private equity interest in Brocade was waning, according to dealReporter reports. On Feb. 3, Bloomberg reported that private equity firm The Blackstone Group (BX) was studying a leveraged buyout of Brocade, however a deal could be a difficult proposition because of the company's $2.63 billion size.

While ThinkEquity analysts report highlighted a private equity deal similar to Thoma Bravo's $1.3 billion purchase of Blue Coat Systems (BCSI) as strong precedent for a deal, the Bloomberg reports signaled that the small-sized private equity firms would not remain in a bidding process.

Even after long-rumored strategic acquirers of Brocade like Dell (DELL) and IBM (IBM) fell by the wayside as they cut other deals in the networking space in 2011, hedge funds nonetheless piled into Brocade's stock in the fourth quarter.

Highbridge Capital Management bought over 2.3 million Brocade shares, while Millennium Management and Two Sigma Investments build 1 million share-plus sized stakes in the quarter. Meanwhile, Caxton Associates, Delaware Management and Pyramis Global added roughly 1 million shares to their holdings. For Highbridge, Brocade is now the funds third largest holding, according to its latest filing.

Brocade's shares have risen over 11% in 2011, adding to a fourth quarter gain of over 25% as earnings recovered and sale speculation intensified. Nevertheless, Brocade's shares fell in 2011 after a halving of the company's stock between June and August when some takeover candidates were removed from the M&A market.

If a Brocade sale were to emerge, the investment might match a 2010 sale of Novell, after the investment fund took a large stake and pushed for its eventual $2.2 billion sale to Attachmate.

In 2011, Brocade saw its profits fall by over 50% to just over $50 million, while revenue grew over 5% to $2.1 billion. In its most recent quarter ended in September, Brocade posted a $4.3 million net loss - its first losing quarter since the third quarter of 2009.

Brocade is expected to earn $2.2 billion in sales and $87.9 million in profit in 2012, according to consensus estimates of analysts polled by Bloomberg, who give the company's shares a price target of $5.88.

Other large Brocade shareholders include Franklin Resources, Fidelityand Vanguard, each with over 5% stakes in the company's shares.

For more on Brocade, see stocks under $10 setting up to trade higher .

>>To see these stocks in action, visit the 5 Deal-Ready Stocsk Loved by Hedge Funds portfolio on Stockpickr.

-- Written by Antoine Gara in New York

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