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Brocade analysts coo, investors sell

Analysts come up with ornate reasons to maintain their "buy" ratings after the company's third-quarter results. But most lower estimates, and investors take that as a cue to sell.

3 min read
Analysts of Brocade Communications Systems came up with some ornate reasons to maintain their "buy" ratings Thursday following the company's third-quarter results. But the bottom line is, most lowered their estimates for the maker of computer storage networks, and investors took that as a cue to sell.

Shares fell $4.34, or 14 percent, to $26 Thursday, continuing their decline from a 52-week high of $133.71.

The storage business has been in trouble for a while now; industry leader EMC produced a profit warning in June, which resulted in a decline for Brocade and similar companies. Those companies were also suffering Thursday: EMC was off 40 cents, to $15.70; IBM fell 79 cents to 104.22; Network Appliance dropped 77 cents, to $12.35; McData shed $2.36, to $13.26; and Sun Microsystems lost 48 cents, to $14.29. CNET's Storage index dropped 5 percent.

The declines were in spite of Brocade's solid third quarter and analysts' reassuring comments.

Brocade reported that net earnings were $12 million, or 5 cents a share, in its third quarter, in line with First Call's estimates. Sales also did well, rising to $116.3 million from $92.1 million a year ago, and just topping First Call's prediction of $116 million.

The only bad news in the report was already expected: Earnings were down sharply from the $20.1 million, or 8 cents per share, that the company brought in during last year's comparable quarter.

"Not much to complain about here," wrote ABN AMRO analyst Bill Shope, who maintained a "buy" rating on shares. He even called Brocade's outlook "encouraging" since it essentially remained unchanged: The company said it expects flat fourth-quarter earnings of 5 cents a share. That's a penny below First Call's consensus, but this shouldn't be a reason for concern, Shope noted, since "the shortfall should be the result of increased investments in operations as opposed to slackening demand or aggressive pricing."

The company also guided Wall Street to expect a sequential increase in revenue of 3 percent for the fourth quarter. Needham & Co. analyst Glenn Hanus noted the growth is a good sign, indicating growth in IT spending in the SAN (storage area network) category.

Analysts also said the company's new switch, Silkworm 12000, is on schedule and should help business once it makes it to market by year's end. "We believe the introduction of Silkworm 12000 will fill (a) gap in (Brocade's) product line," wrote J.P. Morgan analyst William Lewis, who also maintained a "buy" rating on the stock.

Lewis also cheered that "the worst could be over for the company."

"Positive spending patterns emerged in July for the industry, and we believe that this will carry over to the fourth quarter of 2001," he added.

Ratings stay, but estimates drop
Though analysts praised the company's performance and maintained their bullish ratings, they also lowered their estimates for the October quarter and into 2002.

Hanus lowered his fiscal 2001 estimates to earnings of 28 cents a share on revenue of $516.5 million, down from earnings of 30 cents a share on $524 million. Hanus cited risks, including competitor McData's growing lead in some switching categories, as well new technologies such as storage over IP that may threaten the company's Fibre Channel based protocols in the future.

Lewis also dropped his estimates for 2001 and 2002, along with his price target, which fell from $45 to $40 a share. The analyst said he needs to see "more certainty on core switch volume shipments and stabilization of forward estimates" before raising his numbers again.

The only analyst who didn't try to hedge lowered estimates with upbeat sentiment was U.S. Bancorp Piper Jaffray analyst Ashok Kumar. He said checks with the company's customers have indicated that "SAN implementation remains anemic due to weak IT spending (and) glut in storage capacity."

Kumar also dismissed the promise of Silkworm 12000. Brocade is "expected to face stiff competition from Cisco and a host of private companies," on that front, Kumar wrote. The analyst's lack of hope in the stock was reflected in his rating--"neutral"--and the title of his Thursday morning report: "Elvis has left the Building; Reducing Estimates."