Brocade Communications Systems' meteoric rise on Wall Street came to a screeching halt in February when it warned that second-quarter sales would fall 30 percent from the preceding quarter--a confession that sent its shares tumbling.
On Tuesday, Wall Street will find out if this was merely a blip on the radar or an ominous sign of things to come for a company that's trading at roughly 80 times its projected earnings for fiscal 2002. This is a pricey valuation by any measure, but downright cheap compared with its 52-week high of $133.72 per share set just six months ago.
The stock closed at $40.09 Monday.
That's the thing with Brocade (Nasdaq: BRCD): Everyone wants to own it because it holds such a commanding lead over its competition in the Fibre Channel switching and management software market for SANs (storage area networks).
"Brocade has and continues to trade at a huge multiple," said Joel Pitt, an analyst at SunTrust Equitable Securities. "That multiple implies not only that it will continue to hold a dominant share of the market, but assumes that the market will continue to grow at an incredible rate and that Brocade will maintain its incredible margins."
Two weeks ago, Brocade executives told analysts attending the Merrill Lynch Hardware Technology Conference that it would meet or perhaps beat lowered estimates in the second quarter.
Some analysts have suggested Brocade deliberately watered down estimates this quarter to set itself up for some artificially induced good will if it does top estimates this time around.
Analysts are now forecasting a profit of 5 cents a share on sales of $118.7 million, according to First Call.
"They did lower the bar dramatically, but it's wasn't terribly unexpected," said Shebly Seyrafi, an analyst at A.G. Edwards. "March was clearly their worst month and orders fell much faster than anyone could have predicted. But it appears there's been a rebound lately."
From Brocade's perspective, it made sense to err on the downside, especially after the San Jose, Calif.-based company managed to hurdle analysts' estimates in the first quarter just as investors were beginning to recognize the magnitude of the current economic malaise.
"Frankly, I expect they'll beat the numbers this quarter," Pitt said. "I don’t think they deliberately misled investors in previous quarters when they gave such optimistic guidance. And I don't think they did so this time, either. You can't blame them for being cautious because we all know what happens to a company when it sets targets and then comes up short."
On Friday, CS First Boston analyst Amit Chopra weighed in on the Brocade situation by initiating coverage of the stock with a "buy" rating and set a 12-month price target of $52 a share.
In a research note, Chopra justified the rating by saying the company "is now driving the evolution of the switch from its roots as a hardware-based packet passing interconnect to a launching pad for SAN management services."
"With these higher level services, the company is laying the groundwork for the build-out of more scalable and distributed storage fabrics," Chopra said.
More than a few analysts have compared Brocade's prospects with those of some of the most successful companies in the industry.
"Some people say it's the next Cisco," Seyrafi said. "But I think that might be a bit of an overstatement."
In fact, Seyrafi said Cisco Systems (Nasdaq: CSCO) actually poses a considerable threat to Brocade in the long run.
"Brocade is going to face more competition from Cisco's (storage) plan," he said. "For a long time, people have been saying that Brocade would be so huge that Cisco couldn't cut into its lead. But because the economy has been so poor lately, Brocade hasn't been able to build on that lead and might have left the door open for Cisco."
Analysts are expecting more conservative guidance from Brocade for the third and fourth quarters, but they want to know more about the company's inventory. Last quarter, its inventories surged 314 percent from the preceding quarter to more than $5.7 million.
"While we're bullish on the storage sector and really like Brocade as a company, we think most of the best companies in this sector are trading at prices that they can't possibly justify," Pitt said.