Brocade a Top Buyout Prospect for 2013

NEW YORK ( TheStreet) -- It's official, I'm going to file network equipment maker Brocade ( BRCD) at the top of my list of buyout candidates for 2013. This is a list that also includes (among others) Palo Alto Networks ( PANW).

Although Brocade has performed quite well this year, the market seems to show no interest in discussing the company's prospects unless it involves M&A speculation. And it seems that the company's strong fourth-quarter performance has only served to fuel that fire.

Brocade ended the year on a strong note. Fourth quarter revenue grew 4% sequentially and improved 5% year-over-year to $578.3 million -- easily beating consensus estimates of $566 million. This is certainly encouraging -- particularly given how tech stocks have disappointed investors due to a poor macro environment that has hurt enterprise spending.

The company was helped by better-than-expected performance in product revenue, which improved 7% year-over-year and 5% sequentially. Likewise, profitability was impressive. The company reported GAAP net income of $54 million. This compares to a loss of $4 million in the year-ago quarter as operating income also grew 12% year-over-year.

The company reported GAAP earnings per share of 11 cents. This compares to a 1 cent loss last year. Non-GAAP earnings per share rose by a penny to 17 cents per share -- beating analysts' estimates by 3 cents. The same, gross margin improved by almost two points year-over-year and by one point sequentially.

For the company's performance, CEO Michael Klayko said this:
Q4 was an excellent quarter for Brocade and a strong ending for fiscal 2012 during which we established a number of company records including revenue, net income and operating cash flow. Our product portfolio across all areas of our business is the strongest it has ever been and we are driving industry transformation in emerging areas of growth including virtualized data center, cloud computing and software-defined networking

After such a strong performance, it's hard to disagree. Although Brocade lags behind bigger rivals such as Cisco ( CSCO), the company is clearly outperforming Dell ( DELL) and Hewlett-Packard ( HPQ). But I wonder how long this performance can last without some type of a trip-up due to the expected change in leadership now that Klayko is leaving.

It goes without saying that the strategic direction of the company will be determined by Klayko's replacement. That said, it's hard to imagine a better time than now for M&A speculation.

Cisco remains at the top of my list of suitors. Not only does Cisco have the financial means, but equally important are the synergies that align very well.

What's more, Brocade has more than doubled its free-cash flow over the past five years, making this a buy that Cisco can easily justify. Too, a deal like this would help strengthen Cisco's enterprise and cloud position and would also be a good defensive play -- keeping Brocade out of the hands of rivals like EMC ( EMC), Hewlett-Packard and even Dell.

As enterprise spending continues to recover, there is a chance that Brocade will begin to see its stock price appreciate a bit more. Also, the company continues to be underestimated when it comes to discussing its preparation for the cloud. To that end, Brocade has taken a slightly different approach toward organization and deployment.

The company understands that networks must be cloud-optimized at every critical point because companies will define not only the application performance but more importantly, the end-user experience.

Nonetheless, I do worry that the bigger names within the sector will add increased pressure. In the meantime, as Brocade continues to trade at these levels, buyout rumors will persist and I expect that Cisco will close the deal in 2013. If it's good enough for Cisco, Brocade should certainly be good enough for investors.

At the time of publication, the author held no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.