When a company with close to $19 billion in revenue clomps its way into a technology market that's worth a mere $1 billion, it's time for competitors to get nervous. So Cisco's entry into the storage switch market must have caused some tremors at Brocade ( BRCD) and McData ( MCDT), which together command nearly nine-tenths of the existing market. The news came via Cisco's announcement Tuesday that it is acquiring Andiamo, a privately held company that is developing switches for storage-area networking. Cisco had previously released some details of a deal to acquire an unnamed privately held company in its 10-Q filed in March. The networker will pay up to $2.5 billion, depending on trial sales of Andiamo products and Cisco's sales and market cap at the time the deal closes, which is expected to be sometime in the first half of 2004. Andiamo's products will become available in the fourth quarter of 2002. On a day that saw heavy tech selling, shares of Brocade lost 2.7%, or 44 cents, to close at $15.74. McData gave up 2%, or 21 cents, to $10.15, while Cisco ( CSCO) eked out a penny gain, gaining 0.1% to close at $14.73. Cisco's latest play isn't likely to sit well with Brocade and McData investors, who have good reason to fear market share incursions by the networking giant. "Cisco has the money to invest, the ability to quickly get up to speed and make sure their product offering is at least comparable to what's on the street and preferably better," says Eric Sheppard, a senior research analyst at IDC. "We're talking about two companies that have hundreds of millions in revenue, and Cisco's got billions." Cisco also boasts massive cash reserves that it could funnel towards R&D to refine Andiamo's switch technology. The company claimed nearly $9 billion in cash and short-term investments as of the April quarter. Compare that with Brocade's balance of $206 million and McData's $178 million. Over the longer-term, Cisco's technological focus could give it an edge. "Cisco's technology is basically in the IP Ethernet technology; it's their core product capability," points out James Opfer, the chief analyst at Gartner Dataquest in storage network infrastructure. In contrast, Brocade and McData work with partners in those areas. "I'm not saying they don't have adequate partners, but there's a difference in degree," says Opfer. "In the longer term, as the connectivity of storage extends over the IP networks or across Ethernet, a good understanding of that is a competitive asset." Asked about the potential for share losses, McData chairman and co-founder Jack McDonnell counters that Cisco's purchase will actually increase the size of the overall market pie. "They're bringing fiber channel switches into the mainstream, at least from the market perception point of view. With some of their marketing capability, they're really going to enlarge market opportunities and bring more users into the space," he says. He downplays the potential for pricing pressures down the road. Despite the economic downturn, average selling prices for switches have stayed flat for at least three quarters. "Cisco has historically been a fairly high-priced product supplier. I don't think there will be tremendous compression of pricing as a result of the Cisco entrance," says McDonnell. McData will reveal details about new products in the next couple of quarters that could "significantly" drive down costs in the fiber channel space, he adds.
Cisco Has Work Cut Out For It
Indeed, for all the advantages Cisco enjoys, making inroads into the switch market will be far from a cinch. "Though Cisco knows a lot about computer networking, they haven't demonstrated their proficiency at all in storage networking, and it is different. They've got quite a learning curve," says Steve Berg, an analyst at Punk, Ziegel. One of Cisco's biggest challenges is that both Brocade and McData already have deep ties with so-called OEMs such as IBM ( IBM), EMC ( EMC) or Dell ( DELL), which sell the majority of their products. "Cisco didn't announce any relationship with storage vendors," points out McDonnell. Those relationships are a "tremendous asset for McData and probably a disadvantage for Cisco." "Cisco has traditionally not been an OEM supplier," explains Sheppard. "So they have to change the way they sell switches to accommodate the way people purchase SAN storage area network switches, through systems suppliers. That means possibly losing their brand to a Dell or EMC which would rebrand it. Or, they need to change the way end users buy storage networks. By that I mean to break apart the sale of the infrastructure from the sale of the system," Sheppard says. From that standpoint, at least, Cisco's massive coffers won't be much help. Meanwhile, from the networker's standpoint, there's a question of "how much share of the market do they have to grab in order for it to make an impact," says Berg. Cisco is so big -- with sales of about $19 billion over the past year -- that its entry into the switch business probably won't make much of a difference in its topline. To put things in perspective, the entire switch market, currently valued at around $1.2 billion, is expected to grow to only $4.3 billion by 2006, according to Gartner Group estimates.