Brocade Communications Could be Attractive to Oracle: Analyst

Brocade Communications Systems Inc. (NASDAQ:BRCD) could come in to spotlight after Blue Coat Systems Inc. (NASDAQ:BCSI) said Friday it has agreed to be acquired by an investor group led by San Francisco-based private equity investment firm Thoma Bravo, LLC, for about $1.3 billion.

We believe the takeout of BCSI may bring BRCD into the spotlight given the presence of activist investor Elliott Associates as a major shareholder in both companies, ThinkEquity analyst Rajesh Ghai wrote in a note to clients.

In addition, Brocade could also get the attention of Oracle Corp. (NASDAQ:ORCL) that would diversify the business software maker in to hardware business. California-based Brocade makes networking gears including switches, routers, fabric-based software applications, host bus adapters, converged network adapters, mezzanine cards, and switch modules for bladed servers.

We believe the BRCD asset would be attractive not only to a FCF hungry PE investor like Thoma Bravo but potentially to a strategic buyer like ORCL trying to fill in a Networking hole in the product portfolio, Ghai said.

Meanwhile, Ghai expects the speculation that Elliott may drive a similar transaction at Brocade could benefit the stock in the near-term. Bluecoat Systems had entered into a standstill agreement with activist investor Elliott Associates which owned about a 5.7 percent stake in the company.

Elliot Associates raised its stake in Brocade by 2 percentage points in November and now owns a 9.5 percent stake in the company.

Although BRCD has not entered into a similar standstill agreement at BRCD, we believe its motivations are probably similar to what it had at BCSI - to unlock shareholder value by driving a sale, Ghai said.

The analyst said Brocade like Bluecoat Systems is an undervalued asset and its fundamentals are far superior to Bluecoat Systems. It has a strong free cash flow storage area network (SAN) business and a growing local area network (LAN) business.

At current valuation, BRCD trades at roughly 8.4x trailing FCF, which is inline with the takeout multiple at BCSI. However, considering the stronger fundamentals at BRCD vis-a-vis BCSI, we believe one could argue for a higher multiple at BRCD, added Ghai who has a buy rating and $6 price target on Brocade Communications stock.

Shares of Brocade Communications closed Friday's regular trading session at $5.55 on Nasdaq.