Brocade Communication Systems, Inc $1.2 Billion Acquisition Leaves Investors Wanting

By Markets Fool.com

Image source: Brocade Communications.

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The deal storage area network (SAN) provider Brocade Communications inked with wireless Internet supplier Ruckus Wireless on April 4 would seem to be a natural fit. Brocade and Ruckus offer an array of complementary products and services in fast-growing markets including wireless mobile connectivity, data storage, and data center networking hardware.

Due to ancillary product offerings, the existing customer bases of each offers a world of upsell opportunities, and is likely the reason CEO Lloyd Carney expects the deal to be accretive to Brocade earnings by this time next year. Alas, while Ruckus shareholders were smiling all the way to the bank, Brocade stock was being trounced on Monday following the acquisition news.

But as so often happens after drastic declines in a company's share price, Brocade's precipitous drop could prove to be a value investor's dream.

Just the facts
The deal calls for $6.45 per share in cash, plus 0.75 shares of Brocade for each Ruckus share. The total cost of the acquisition is $1.5 billion, which includes approximately $300 million in cash on Ruckus' books, bringing the net value to $1.2 billion. Brocade intends to pay for the deal with "a combination of cash on hand and new bank term loan financing."

Brocade said the deal adds, "Ruckus' higher-growth, wireless products to Brocade's market-leading networking solutions." Ruckus' strength in the Wi-Fi market is also expected to expand Brocade's business with service providers.

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Perhaps most intriguing for shareholders is the impact the acquisition has on Brocade's concerted efforts to grow its Internet of Things (IoT), emerging market 5G mobile services, and smart cities -- all markets with tremendous upsides as the world moves to a digital, data-driven marketplace.

What went wrong?
Though the acquisition, which is expected to close in Brocade's fiscal 2015 Q3, looks good on paper, the more than 13% drop in value following the news made it clear investors don't share Carney's optimism. There are a couple of likely reasons for Brocade investors' angst.

Brocade already carries $798 million in long-term debt on its books and that, combined with its $1.39 billion in ready cash, may be concerning to some shareholders considering the acquisition price. However, Brocade's debt-to-equity ratio of 31.33 is in line with that of its industry brethren and is considerably lower than those of many storage and networking providers.

Of course, Brocade's intention is to finance the deal for Ruckus, at least in part, by increasing its existing debt load, so that relatively sound debt ratio will take a turn for the worse before long. There's also the small matter of agreeing to a 30% premium for Ruckus shares. The upside is that Ruckus reported a record Q4 in which it generated $100.1 million, good for a 16.6% improvement from the year-ago period. For the year, Ruckus generated total sales of $373.4 million, a 14% improvement compared to 2014.

Though Ruckus is heading in the right direction from a growth perspective, the net $1.2 billion acquisition price may still appear steep to some Brocade investors.

Despite reporting flat revenue last quarter, Brocade was able to boost earnings per share (EPS) on both a GAAP (including one-time items) and non-GAAP (excluding one-time items) basis by 15% and 12%, respectively. The EPS growth was largely due to a more friendly tax situation than a year ago, and the continuation of Brocade's share buyback initiative.

Brocade has nearly 25 million fewer shares outstanding than it did at this time last year, and announced it would boost its buyback plan up another $800 million in the coming year. That's impactful given Brocade has "just" 400 million shares outstanding. And at current levels, Brocade's repurchase plans couldn't come at a better time.

Brocade's deal for Ruckus didn't strike a positive chord with many, which has made an already undervalued stock even more attractive. Trading at just 8.6 times future earnings, paying a nearly 2% dividend yield, and adding complementary products from the Ruckus deal equates to an opportunity for long-term value investors

The article Brocade Communication Systems, Inc $1.2 Billion Acquisition Leaves Investors Wanting originally appeared on Fool.com.

Tim Brugger has no position in any stocks mentioned. The Motley Fool recommends Ruckus Wireless. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.