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THE DAY AHEAD: Kumar vs. Brocade: Who&#039s right?

Say what you will about USB Piper Jaffray analyst Ashok Kumar, but he doesn't run with the herd. With shares of Brocade Communications trading near 52-week highs amid stellar third quarter results, Kumar hasn't been able to find anything nice to say about the company.

Kumar's attacks have been met with a resounding "Huh?" on Wall Street. On Monday, Kumar noted that Brocade (Nasdaq: BRCD), a leading fiber channel storage area networking (SAN) company, is "the last man standing in an increasingly unhealthy industry."

Brocade, which is priced to perfection, could see a sharp downturn once quarter-to-quarter revenue growth starts slowing, said Kumar in a research note.

Kumar said Brocade is merely capturing a large share of a shrinking market. Kumar noted that Sun (Nasdaq: SUNW), EMC (NYSE: EMC), Hewlett-Packard (NYSE: HWP) and IBM (NYSE: IBM) haven't fully embraced fiber channel storage (get background), which will be replaced with Internet protocol storage. "The fact that fiber channel has been around forever and doesn't have support says a lot," he told ZDII in a phone interview. "Fiber channel has the shelf life of a fruit fly."

The outspoken analyst said IP SAN products are the next frontier and Brocade doesn't have a plan. Meanwhile, Kumar said he isn't seeing large-scale fiber channel SAN installations in the enterprise. Brocade officials weren't available for comment about Kumar's latest rant.

Kumar's criticism

Monday's Brocade note wasn't anything new from Kumar, who has spent most of his summer taking shots at Brocade.

On June 14, Kumar noted that a joint development deal with Cisco Systems (Nasdaq: CSCO) left Brocade vulnerable. Cisco will focus on Internet protocol SAN products, which Kumar believes is the future. On June 22, Kumar said Brocade's trumpeting of becoming an industry standard was "astute wool pulling." Kumar pointed out that competitors showed they could reverse engineer Brocade's technology.

After a little break Kumar went on the attack again. In a July 31 note, Kumar said Cisco acquired technology that will make the fiber channel industry moot. Cisco's acquisition of privately held Nuspeed would transport storage traffic over IP networks. "By acquiring Nuspeed, Cisco demonstrates their interest in becoming a serious entity in the storage networking market," said Kumar. "Although Brocade has attempted to put down the concept of storage over IP for many years, it must be obvious to them by now that it is a serious threat to their business."

And that dose of history brings us to Kumar's note on Monday. Kumar's bottom line: Fiber channel storage sales growth will decline starting in about six to nine months. When sales growth slows, Brocade shares will crater because they're already ridiculously overvalued.

Through Aug. 16, Brocade was trading at 170 times calendar 2001 earnings, compared with 80 times for Cisco and 90 times for EMC (NYSE: EMC).

But Brocade is booming

Despite the valuation concerns, it doesn't take too much effort to find a bunch of people who think Kumar has a vendetta against Brocade.

For starters, Brocade reported third quarter earnings of 16 cents a share, topping estimates easily. Sales in the quarter topped $92 million, up 48.5 percent sequentially. Brocade's quarterly revenue growth is accelerating despite the laws of large numbers.

Couple those results with bullishness from CEO Greg Reyes, who noted on a conference call that Brocade's addressable market is growing by the day, and you have a lot of investors thinking Brocade is the next Cisco.

Mark Specker, an analyst at WitSoundView, reckons that Brocade's earnings report "should be enough to support the stock at current levels." Specker said investors could see 25 percent upside in the next four months. He projects a price target of $250.

Goldman Sachs, Robertson Stephens and a host of others all upped their earnings and revenue targets. Analysts told ZDII that Kumar is way out on a limb with his Brocade call. They're right -- at least for now.

Kumar's response? "They're just regurgitating what the company says," said Kumar.

Is Kumar right?

So far, Brocade's numbers don't reflect anything that would indicate the company is going to hit a dry spell. "The numbers are good," said Kumar. "You can't argue with that, but the point I'm trying to make is that you need to step back and look at the forest, not the trees."

But Kumar said technology religious wars don't pan out, especially when it could be Cisco vs. Brocade.

And now for Kumar's track record. To his credit, Kumar flagged slowing growth at Dell Computer (Nasdaq: DELL) ahead of others. Kumar is still ahead of the game as he disputes Dell's 30 percent revenue growth targets.

Kumar has also received a lot of flap over his other calls. Kumar shot down eMachines (Nasdaq: EEEE) before it even went public. Cynics noted that Kumar's firm didn't get the IPO underwriting work. Kumar said he was just calling 'em as he sees 'em. Turns out Kumar was on target, but the eMachines call wasn't exactly rocket science.

On the negative side, if you had listened to Kumar's calls on Advanced Micro Devices (NYSE: AMD) and Brocade, you would have left a lot of cash on the table. Brocade shares have doubled since Kumar first started his parade of negative research notes.

In any case, the debate over Brocade should give investors an excuse to do some more homework. A herd can change directions quickly, and even if Kumar is only half-right, Brocade shares could burst. Brocade isn't likely to trade at 170 times future earnings forever.

TDAIN
• More on storage area networking
• Brocade shrugs over bearish report
• Brocade zips past third quarter estimates
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