Downgrade hammers Brocade shares

Brocade Communications shares tumbled 16, or 15 percent, to 94 1/4 after USB Piper Jaffray cut the maker of equipment for storage area networks from a "buy" recommendation to a "hold."

Analyst Ashok Kumar downgraded Brocade (Nasdaq: BRCD) after privately held Nishan Systems rolled out a rival product that could erode its head start in this burgeoning market.

"The fat lady sings," Kumar said in a research note.

Nishan said it was launching competing equipment that incorporates both Internet and old-line Ethernet networking standards for moving data around offices. It also signed investment agreements "with a number of the world's leading storage and computer companies."

Last week, Brocade (Nasdaq: BRCD) easily eclipsed analysts' estimates in its second quarter, raking in $13.3 million, or 11 cents a share, on sales of $62.1 million.

Since its initial public offering in May, Brocade shares have twice split 2-for-1 while sailing up to a 52-week high of 185 in March.

Equally impressive, Brocade's gross profit margins jumped to 58 percent in the quarter, up from 53 percent in the previous quarter.

Last week, Kumar warned that while Brocade's sales and earnings have been impressive, the threat of competition and the rapidly changing dynamics of the industry could interrupt its terrific growth.

"What this really means is the market is moving from single server, single storage installations to include multiple servers and storage subsystems on a storage network together," Kumar said. "However it is dangerous to extrapolate the numbers we have seen so far to say that it will be a large market. It just seems to have all the markings of an early adopter market."

Other analysts point to the stellar sequential improvements in both sales and profit margins as a sign that Brocade has yet to hit its peak.

Laura Conigliaro, an analyst at Goldman Sachs, predicts sales growth of 259 percent and 72 percent for fiscal 2000 and 2001, respectively, with expanding opportunities and an extremely healthy storage area network market probably driving growth higher.

"We see Brocade as an emerging leader in the exploding storage networking space," Conigliaro said in a research note. "We believe investors should be well-exposed to various segments including companies in storage systems, storage software, the newly emerging storage utility segment and storage networking."

Robertson Stephens analyst Paul Johnson raised his fiscal 2000 earnings estimate to 46 cents a share from 34 cents a share and upped his fiscal 2001 estimate to 70 cents a share from 44 cents a share.

"We believe the strength in the quarter was due to continued strong growth in sales of fibre channel based storage equipment and the building momentum of the company's systems integrator business," he said in a research note. "In the first calendar quarter, Brocade continued to take market share with 68 percent of the fibre channel systems business, and 38 percent of the overall fibre channel market."

Despite the rosy outlook, Brocade shares are trading at a price-to-earnings ration of around 1,161 with a market capitalization of more than $13.2 billion.

First Call consensus expects the San Jose, Calif. company to earn 12 cents a share in its third quarter and 41 cents a share in the fiscal year.

Twelve of the 13 analysts following the stock rate it either a "buy" or "strong buy."