Brocade's Direction Is Now Clear

NEW YORK (TheStreet) -- It's hard to imagine that there was a point when the Street was wondering whether Brocade (BRCD) had a pulse.

Not only had the company floundered in the IT enterprise market where it competes with rivals like Cisco ( CSCO) and Juniper ( JNPR), but Brocade, which just installed a new CEO, couldn't convince investors that operational changes would make a difference. On Tuesday, all of that was forgotten.

Helped by efficient cost controls, Brocade surprised the Street with a better-than-expected profit of $118.7 million. Excluding one-time items such as a legal settlement worth $77 million, the company earned 19 cents per share, beating last year's EPS by 36%. The stock responded by jumping more than 16%.

As we've seen from other hardware vendors, which have suffered due to weak IT spending, there now appears to be a meaningful recovery in enterprise capital expenditures.

Companies no longer seem interested in starving themselves. In the case of Brocade, it is clear that demand in the storage market is recovering faster than the company had predicted, which supports my recent confidence in storage giant NetApp ( NTAP).

What's impressive about Brocade, though, is that the company's product portfolio appears strong across all areas of its business. And it's also encouraging that these products are driving industry transformation in emerging areas of growth including virtualized data center, cloud computing, and software-defined networking (SDN). Cisco, via its recent acquisitions, has been trying to build its capabilities in SDN

I like Brocade's prospects. But I'm not going to pretend that this is a flawless company. The revenue situation hasn't been that impressive. I think it's a mistake, though, to judge Brocade solely on this basis. It's a popular bear argument. But this is a company that has produced solid free cash flow for eight consecutive years and strong margins. That the company continues to grow market share in its core storage area network, or SAN, business is also an indication that its strong technology is still highly regarded.

To that end, while Brocade may be a tough matchup for, say, Cisco, Brocade is clearly outperforming Dell ( DELL) and Hewlett-Packard ( HPQ). This is even though Brocade reported a 3% decline in revenue, much of which was due to lower-than-expected sales to the U.S. federal government. Even so, the Street now seems pleased with the company's new direction and that management has shown that it can do more with less.

After such a strong performance, I imagine talks of an acquisition will re-emerge and that Cisco will once again be at the top of the list of suitors. On many levels, this seems sensible to me. Not only does Cisco have the financial means to make this deal happen tomorrow, but the two companies would have obvious synergies. What's more, Brocade's ability to more than double its free-cash-flow position over the past five years makes the company hard to pass up.

Plus, Brocade would help strengthen Cisco's enterprise and cloud position, while Cisco, which has been on a recent shopping spree, could do this deal just to play defense and to keep Brocade out of the hands of EMC and possibly Oracle ( ORCL).

As of this writing shares of Brocade are trading at more than $8 following a Tuesday close of $6.90. There's the obvious concern that buyers may have gotten overexuberant.

But as enterprise spending continues to recover, there's justification for the optimism. And even if there is a pullback, the chance that this stock will appreciate over time becomes greater, especially given how well management has cleaned up the balance sheet.

It's going to be tough to recommend a stock that has soared to a new 52-week high. But I still see some upside potential here. Granted, the stock does not offer the safety of Cisco. But I think for investors with a high frustration thresholds and an appetite for risk, Brocade can be solid play in the enterprise storage/network segment for the next 12 months.

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

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

Richard Saintvilus is a co-founder of StockSaints.com where he serves as CEO and editor-in-chief. After 20 years in the IT industry, including 5 years as a high school computer teacher, Saintvilus decided his second act would be as a stock analyst - bringing logic from an investor's point of view. His goal is to remove the complicated aspect of investing and present it to readers in a way that makes sense.

His background in engineering has provided him with strong analytical skills. That, along with 15 years of trading and investing, has given him the tools needed to assess equities and appraise value. Richard is a Warren Buffett disciple who bases investment decisions on the quality of a company's management, growth aspects, return on equity, and price-to-earnings ratio.

His work has been featured on CNBC, Yahoo! Finance, MSN Money, Forbes, Motley Fool and numerous other outlets.

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