Brocade Eyes Cisco Customers With $3B Foundry Buy

San Jose, Calif.-based Brocade said Monday it has agreed to pay US$3 billion to acquire one of Cisco's much-smaller competitors, Foundry Networks , to try and make that happen.

The proposed acquisition would meld two companies with presence deep in the data center and pose a direct challenge to Cisco, which at $29 billion in annual sales is the world's leader in Internet networking equipment.

Becoming More Well-Rounded

Surging Internet traffic, especially in bandwidth-hogging video, has driven intense demand for the routers and switches that direct Internet traffic, Cisco's home turf. That's also lifted the fortunes of Cisco's smaller rivals, including Santa Clara, Calif.-based Foundry Networks, which specializes in high-end networking gear, making them attractive takeover targets.

Brocade wants Foundry Networks because Brocade's primary business -- it's dominant in a type of switch that connects servers to data storage machines -- is under pressure. Data centers are changing, and networking companies are eying acquisitions or expensive R&D efforts to come up with technologies that make the servers, storage and related equipment more robust and easier to manage.

The acquisition promises to make Brocade a more well-rounded competitor to Cisco, but isn't likely to substantially dent Cisco's dominance because Foundry Networks, with $607 million in sales last year, is considered a niche player.

Foundry owned just 2 percent of the market for Ethernet switches in 2007, while Cisco had 71 percent, a huge lead in supplying essential networking gear, according to data from the Dell'Oro Group research firm.

'Bound to Happen'

Alan Weckel, a senior analyst with Dell'Oro, said competitive pressures probably drove Brocade into pursuing Foundry Networks, since Cisco is pushing a convergence of technologies that threatened Brocade's business.

Brocade specializes in switches that use so-called Fibre Channel technology.

As servers become more powerful, and information technology managers demand more control over increasingly complicated machinery, Cisco has been advocating that the Fibre Channel and Ethernet technologies themselves should be merged somewhat -- a direct assault on the core business of Brocade and Foundry Networks, Weckel said.

"Enterprises are really looking to reduce the complexity, especially at the high end of the data centers out there," he said. "So a deal like this was bound to happen. It's just a matter of who and when."

An Additive

Brocade executives describe the battlefield as being wide open. They add that all the companies in this space are working quickly to develop products for the next generation of data centers, and that a winner hasn't been crowned.

"Together we're going to be a bigger, stronger company," Tom Buiocchi, vice president of marketing for Brocade, told The Associated Press. "Companies have been asking us for a high-performance, high-reliability alternative (to Cisco). That's one of the reasons behind this transaction."

Brocade currently has about 2,500 employees, and Foundry Networks has about 1,000, Buiocchi said.

He declined to discuss whether Brocade anticipated any layoffs , but noted that Brocade's and Foundry Networks' product lines don't overlap, so there would be few obvious areas to cut. He said the deal is supposed to be "additive" to Brocade and isn't about cost-cutting.

Beating Expectations

The purchase price Brocade agreed to pay works out to $19.25 per share, a 41 percent premium to Foundry Networks' closing stock price Monday before the deal was announced.

The deal is expected to close in the fourth quarter of this year and add to Brocade's profits in 2009.

Also on Monday, Foundry Networks reported second-quarter profits that beat Wall Street's expectations.

The company said its net income was $18.3 million, or 12 cents per share, for the three months ended June 30. That represents a 17 percent jump from the $15.6 million, or 10 cents per share, that Foundry earned in the year-ago period.

Excluding one-time charges, the company earned 17 cents per share, two cents per share better than the average estimate of analysts polled by Thomson Financial. Analyst estimates typically exclude one-time charges.