UBS Downgrades Brocade To Sell, Sees 'Tougher Sledding' Ahead

In a report published Monday, UBS analyst Amitabh Passi downgraded the rating on Brocade Communications Systems, Inc. BRCD from Neutral to Sell, while lowering the price target from $11.50 to $9.00. The enterprise storage market appears to be incrementally challenged, given the recent negative preannouncements by several of the company's peers.

Storage area networking (SAN) is the company's largest business, accounting for about 57 percent of the sales, with IP/Ethernet contributing another 26 percent of the revenues. SAN is also the most profitable segment for the company with gross margins of about 76 percent.

However, "[w]ith weaker trends in storage, a sub-scale IP business, margins close to peak, cost cuts, capital return embedded in street models, we see increasing downside risk to estimates," Passi stated.

In addition, the analyst believes that the IP/Ethernet switching market continues to be intensely competitive, with "formidable challenger" for Brocade Communications, large public cloud service provides accelerating their whitebox agenda, while smaller vendors appear to be attempting to disrupt the market.

According to the UBS report, "The company has a good niche in US federal, which does offer some support. A $1b-plus of buybacks and $100m-plus of cost cuts during the past 2-3 years have been tailwinds but we foresee diminishing returns ahead."

Also, while Brocade Communications has acquired impressive software-defined networking (SDN) assets, they are unlikely to contribute meaningfully to sales until 2016-2017.