By Buying Brocade, Broadcom's Customers Will Become Its Competition

Shares of Brocade Communications Systems, Inc. BRCD surged more than 20 percent on rumors of a potential acquisition by Broadcom Ltd AVGO. The acquisition would push Broadcom into a new market, where it would be competing against its customers, Argus’ Jim Kelleher said in a report.

These “rumor-driven gains” in Brocade’s shares would “quickly melt away” in case Broadcom defers purchasing Brocade and if an alternative bid does not emerge, Kelleher pointed out. He downgraded the rating on Brocade from Buy to Hold.

The rumored deal came to fruition Wednesday morning.

Broadcom would retain the latter’s fiber channel and storage business, while divesting the networking business.

Risky Deal

“While Broadcom tends to lead in its markets, Brocade is a small player in both its main markets of SAN and IP Networking,” Kelleher pointed out. He added that Broadcom has been in acquisition mode and this has created “a diverse provider of semiconductors for a host of communications and computing markets.”

On the other hand, Broadcom is a component maker. Owning actual infrastructure equipment would represent a move by Broadcom into new markets.

“It would of course carry risk, as Broadcom might find itself trying to compete in the storage array market with its semiconductor customers,” the analyst wrote.

In a separate note, RBC Capital upgraded Brocade from Sector Perform to Outperform.